Contents
Tracking profit margins is as essential as tracking the profit itself. Calculating profit is simple, but it is important to know how to see it as a measure of your business. Let’s say Company X spends $900,000 to sell $1 million in products. This means that its profits equal $100,000. On the other hand, Company Y spends $400,000 to come up with $500,000. Their profit may be the same, but would you say that they are equally profitable?
They are not. Because the more money a business spends to generate profit, the harder the small cost shifts are going to hit it. In the situation that, let’s say, health insurance costs increase, Company X is going to generate less profit than Company Y.
From the perspective of profit margin, the difference is that it is measured in percentage or ratio. This relates to profit and total sales made. So, if Company X has $100,000 in profit and makes $1,000,000 in total sales, its profit margin is 100,000/1,000,000, which is 10 percent. On the other hand, Company Y also has $100,000 in profit, but its sales are $500,000, which is 20%. This basically means that Company Y is twice as profitable as Company X.
In this article, we are going to discuss the profit margins that are vital for you to oversee, from the perspective of eCommerce, SaaS, and small business.
How to have a healthy profit margin for eCommerce
As an eCommerce business, you will face various challenges. In order to set a healthy profit margin for your retail store, you need to have a good pricing strategy. This includes:
- Automating. Manual repricing depends on a big budget and a lot of time. The best solution is to automate it, along with other functions that are important to you as a retailer. It makes the operating costs significantly smaller and boosts productivity.
- Inventory management. Inventory management is of an essence. If you run out of a product, you’re in trouble, because people will look for a similar solution elsewhere. Profitability and the inventory go hand in hand.
- Customer service. It is essential that you have call centers up and running, as well as email, so that customers can contact you about any issue. This will make them satisfied and want to buy from you again.
- Boosting order value with discounts. A good discount is the one where the customer feels like they are getting a good deal. The nominal price means less than the relative price. This is where a little psychology kicks in. In the end, a discount can boost profit margins by making the minimum purchase greater than the average sale.
- Dynamic pricing. Dynamic pricing is a new strategy for retailers that enables flexible pricing. If you are in eCommerce, you need to track various things, such as your competition’s pricing, conversions, seasonality, site traffic, etc. Dynamic pricing enables you to always be up to date with fluctuations in the market. This is best done when it’s automated.
Calculating gross margin for a SaaS business
Before we dive into a gross margin example for a SaaS business, let’s clear out some of the basic gross margin definitions:
- Revenue. How much money a company gets for selling its products for a particular period of time. This includes discounts and deductions for returned merch.
- Cost of Goods Sold (COGS). The direct costs of producing the goods that are sold by the company. It consists of the cost of materials that were used to create the product, as well as the direct labor costs.
- Gross profit. It is the business’ revenues minus the costs of goods sold. Basically, it is the profit that your company has made after paying the necessary cost for making and selling the products.
- Gross margin. Gross margin is gross profit presented as the percentage of sales.
Now, when we are discussing a SaaS company, the accurate gross margin is a little harder to determine because you need to have the exact account for COGS. When thinking about COGS, it’s easier to see them as revenue. So, what expenses do you have to make in order to create revenue? A SaaS type of company will have to spend on hosting and customer support, but also on third-party license agreements, data fees, and the like. This is a good way to decide whether something should be included in the Cost of Goods Sold.
Let’s say that both Company X and Company Y are at $100,000 of Monthly Recurring Revenue (MRR). Company X has five customer support representatives, costing $4,000 each on a monthly basis. Everyone one of them has licenses to various software that they require in order to provide effective support. So, in result, Company X has $1,000 monthly costs per employee, and also hosting expenses of about $1,000 on the same basis. On the other hand, Company Y doesn’t use any customer support representatives. In result, they don’t require any licensing for employees. Their hosting expense is about $5,000 on a monthly basis.
What we get as a result is that Company Y has better margins and retains more money on every sale than Company X. The most important factor that decided this is the difference in the cost of customer support representatives.
Small business profit margin
For a small business, you’ll be focusing on two factors: gross profit margin, and net profit margin. Gross profit margin is based on a particular product. You look at the retail price of the product, and subtract the costs of labor and materials used in its production. Then you divide it by the retail price. As for the net profit margin, it determines your whole organization’s profit margin. You take your company’s total sales for a particular time period, subtract total expenses, and then divide what you get with total revenue.
A good profit margin generally depends on the industry you are in, your expansion goals, and your size and longevity. Research your industry and area to know what to expect. If you are happy with your business and your profit margin, then all is fine, but if you want to expand, you need the margin to be higher, because you will be, for example, investing in new equipment or hiring storage facilities. Now, startup businesses usually have high profit-margins because of the low overhead costs. However, this will change as you expand, so make sure that you keep track.
To improve your profit margin, you can do a number of things. If you are familiar with the margin, you will be able to know where you can cut costs. Your overhead needs to be as low as possible for you to still be able to come up with a top-notch product. If your gross profit margin shows that one of your products is made at a higher cost but not selling as well, you can decide to cut it as well. Finally, if your business can do more while keeping the overhead expenses more or less the same, then go ahead and increase your product offerings.
Another approach that can help a small business’ profit margin is finance restructuring. According to the advice from a loan specialist in Sydney, you should have a good accountant do this part of the job for you, as they can aid you when it comes to saving interest on all the business loans that you take on. There is always the possibility that there are cheaper options out there for you. And, of course, when you refinance your debt and save interest that way, your profits will naturally increase.
The fact is that profit margins can pose a challenge. This goes both for determining what they are, and making the right decisions for your company. That is why overseeing them is of a major essence. This is the only way you can really know in which direction you should lead your business.
“The opinions expressed by BizWitty Contributors are their own, not those of BizCover and should not be relied upon in place of appropriate professional advice. Please read our full disclaimer."
