As a small business owner or manager, you need to speak the language of your industry. That includes general business terms, such as capital, gross, net, and — perhaps most important — profit margin.
Understanding profit margins is essential to the success of your company because it means the difference between making enough money to pay the bills and keep the doors open, and declaring bankruptcy and shutting everything down.
But what exactly is a profit margin? Why is it important? And how do you go about calculating this crucial metric? In this article, the experts at Sling will answer those questions and show you how to get control of your margin with some basic math.
What Is Profit Margin?
The term “profit margin” is made up of two distinct words: “profit” and “margin.” Here’s what they mean individually and what they mean together.
In simple terms, profit is the difference between what you earn for a product or service and what you spend to provide that product or service.
In technical jargon, profit is the income (or revenue) for a product or service minus the cost of goods sold (COGS) for that product or service.
Profit is always expressed as a dollar amount.
For example, if people paid $20,000 for your product in a month (or six months or a year) and you spent $5,000 manufacturing and shipping that product in the same amount of time, your profit would be $15,000 ($20,000 – $5,000).
Unfortunately, this simple equation (income – COGS) doesn’t always yield a positive number. If you only brought in $4,000 for your product but you spent $5,000 getting it to market, the math yields a negative number ($4,000 – $5,000 = $-1,000). That’s called a loss and is the direct opposite of profit.
The dictionary definition of margin is an amount by which something exceeds or falls short. In business, margins are usually expressed as a percentage.
Combining the two words creates a term that means:
The amount by which revenue from sales exceeds costs.
This metric is expressed as a percentage and can be positive or negative.
Why Is Your Profit Margin Important?
Banks, accountants, and investors use profit margin as a gauge for the profitability of your business. A high profit margin means you’re doing things right. A low profit margin means you need to make some adjustments.
One such adjustment may be your pricing strategy. If you have a low profit margin, you may need to increase what you charge for your product or service.
Another such adjustment might be your cost of goods sold (COGS). If you have a low profit margin, try finding ways to decrease what you spend to get your product to market.
All of this is revealed when you calculate one little number.
How Do You Calculate Profit Margin?
Gross Profit Margin
Your gross profit margin is the money you spent producing your goods subtracted from what you made on those goods (a.k.a. your gross profit). You then divide your income into that gross profit and multiply the whole thing by 100 to produce the gross profit margin percentage.
It sounds complicated, but it’s really not. Here’s the formula:
Gross Profit Margin = ((Income – COGS) / Income) x 100
Now let’s plug in some hypothetical numbers to see how it works. For this example, your business made $55,000 last month while spending $14,000 to produce the goods.
Gross Profit Margin = (($55,000 – $14,000) / $55,000) x 100
Gross Profit Margin = ($41,000 / $55,000) x 100
Gross Profit Margin = (0.745) x 100
Gross Profit Margin = 74.5%
That’s a strong gross profit margin. But remember, it only takes into account the money you spent producing the goods. It doesn’t factor in other expenses like taxes and loan payments, as well as other streams of income. That’s what the next calculation is for.
Net Profit Margin
Net profit margin is basically the same as gross profit margin, but it adds in all the other expenses you incurred doing business. Costs like rent, advertising, heating and cooling, maintenance on your sales vehicle fleet, and others — all of these are lumped together and added into the net profit margin equation.
Net Profit Margin = ((Income – COGS – All Other Expenses + Other Income) / Income) x 100
Now let’s take the same numbers we used in the gross profit margin calculation to figure your net profit margin. In this example, all the other expenses totaled $8,000. Your business didn’t have any other income.
Net Profit Margin = (($55,000 – $14,000 – $8000) / $55,000) x 100
Net Profit Margin = ($33,000 / $55,000) x 100
Net Profit Margin = (0.6) x 100
Net Profit Margin = 60%
Taken collectively, your net profit (income – COGS – all other expenses) and your net profit margin is your infamous “bottom line.” It’s the primary indicator of the strength of your business.
Lower Your Labor Costs To Increase Profits
Labor costs are one of the largest expenses your business will have to deal with. Whether you factor them into your costs of goods sold or other expenses, they are going to have a dramatic impact on your profit margin.
You can lower your labor costs by harnessing the power of the Sling app.
Add to that budget tools and alerts that prevent you from going over the numbers you’ve set and onboard artificial intelligence that notifies you when you’re about to schedule someone into overtime, and you’ve got a powerful ally in the battle against profit and loss.
You can even set wages per employee or position and see how much each shift is going to cost. And that’s only one of Sling’s many features that will streamline and simplify the way you organize and communicate with your employees.
For more free resources to help you manage your business better, organize and schedule your team, and track and calculate labor costs, visit GetSling.com today.