Why you should focus on your margin
Today we’re talking margin. We’re often asked what numbers business owners need to keep an eye on, and at the top of the list is usually their margin.
Margin comes in two forms – net profit, and gross profit.
Some quick definitions
The net profit margin is the difference between your total sales and your final profit (calculate it as a percentage by dividing your net profit by your total sales).
The gross profit margin on the other hand is the difference between your sales and your gross profit (calculate by dividing gross profit by total sales).
The critical difference between the two is that the net profit margin includes all your expenses. Whereas your gross profit only includes expenses relating directly to selling your product.
What goes where
Lets say you’re a tradesperson.
Your costs for the year would include the following:
Materials used on jobs
Wages from tradies
Wages from office staff
Storage yard rent
The wages from tradies (generally), and the materials used on the job would be classed as direct costs. As your sales increase then we’d expect these costs to go up.
On the other hand, no matter how much you sell you still need to pay the same amount in office wages and rent (until you either decide to scale up/down and change how your business operates).
Understanding the difference between the two is more important than you’d think…
Why it’s important
Keeping track of your margins can give you real time insight of whether you’re:
- Getting squeezed on prices gradually by your suppliers
- Discounting more than you should be
- Selling more of your lower profit items
- Operating costs are gradually increasing without you seeing it
If you’ve got your expenses in the wrong place in Xero then you’re going to get misleading data.
TIP: If you’re not sure if your setup is right then checkout our Xero Healthcheck here. Download our Xero eBook here to unlock your 20% off promo code.
Then use the data you’ve got
Once you’ve calculated your gross profit and net profit margins, use them to increase the profitability of your business.
We recently worked with a small engineering/manufacturing business to increase their profit since lockdown. They had two service lines going into lockdown. Since lockdown, one of the service lines is unsustainable (it related to travel).
We’ve helped them focus on their second service line. Our forecasting with them has shown that if they can:
- Increase customer numbers by 5%,
- Reduce direct costs by 5%, and
- Increase prices by 5%
…then they’ll be able to increase their overall gross profit on the revenue service line by 35%.
Small changes go a long way.
Your homework (yes, sorry….)
Firstly, work out which of your expenses go into your Xero account as a direct cost, and what goes in as an overhead. (Reminder: checkout or Xero eBook here for more info, and a promo code for our Xero Healthcheck).
Then checkout our two recent podcasts talking about margin, what it is and how you can increase it in your business. There, you can download our worksheets to help you calculate the impact of increasing your margin in your business.
If you’re reading this close to our publish date, you might also be able to join our Community Call. Join a group of other business owners coming together to share what they’ve done in practice to improve their margin. If you’d like to find out more on our Community Calls, reach out to us here.
Did you find this article useful?