Smart ways to grow your business using the profit margin calculation
This month, we’re talking about ways you can grow your business - in this post, we’ll explore how you can use profit margin calculations to help inform your plans to grow.
How do I calculate profit margin?
To work out your business’s profit margin, or margin, add up the day-to-day running costs of your business over a set period of time - usually a year, but sometimes a month or a quarter. Don't forget to allocate your costs according to when they are relevant for your business, not necessarily when they were paid - check out our guide to allocating costs here.
Then take the amount of money you earned over that same period, and subtract the running costs from that number. This number is your “net profit”. If you have a set of accounts, you can also pull these numbers from your profit and loss account, or P&L for short.
Take that net profit figure, and divide it by the total amount of money you earned in that period. This is your business’s net profit margin.
Smart ways to break down your profit margin calculation
On its own, a high-level profit margin figure isn’t a very useful metric when planning for growth. Calculating profit margin is most useful when you take it in context, or use it to compare parts of your business.
Profit margin over time
A great place to start is to calculate your profit margin over different points in time - for example, you might compare this year’s margin to last year’s or calculate last year’s margin on a month-to-month basis, and see if your business has kept more profit per pound of sales this year than it did last year.
If you see a difference in the margins, can you pinpoint why that happened? Have your costs gone down since last year, or have you sold higher priced products or services? Try thinking about your business like Google’s stock charts - Google highlights important news and events over the chart’s output, allowing you to pinpoint when events might have shifted the numbers. If a supplier raised their prices in January and your profit margin dipped in February, you may want to dig into those costs - you could potentially look for another supplier, or raise your prices accordingly.
Profit margins by customer type
What is your most profitable kind of customer? For example, if you sell to customers both directly and through a third-party, which channel has the highest profit margin?
There are a lot of interesting ways that you could categorise your customers, so it’s worth thinking about what’s the most relevant for your business - here are some customer type ideas to get you started:
- Size of customer’s business
- Customer’s industry
- Direct customers versus customers through resellers
- Public sector versus private sector customers
- Customer’s location
- New businesses versus older businesses
If you spot any customer types that have a higher-than-average profit margin, you can then start to think about how to attract more of these kinds of customers. Similarly, if you spot any unprofitable categories of customers, you might consider planning to phase out those customers over a period of time.
Profit margin by product or service
If you have a range of different products or services in your business, which one makes the most profit for you?
For example, if you make furniture, is your margin higher for sofas than for chairs, because there are extra costs involved in making sofas? Once you’ve spotted any whose margin is above average, you can think about how to sell more of that product. Or, you might consider raising your prices on a product with a less-than-healthy profit margin.
If you sell time-based services in your business, which services work out as the most profitable for you? Don’t forget to take both your billable and non-billable time into account - you can track both in FreeAgent, and tracking non-billable time is an important way to keep an eye on the true profitability of each service.
Profit margin by project
If you track your work by projects, which project is earning you the highest profit margin? Luckily, you can use FreeAgent to automatically report on the profitability of your projects.
Tracking profitability by projects allows you to break down your profit margin at a very granular level, and it might be useful to group together your project types to look for trends. For example, if you are a graphic designer, do you always spend more unbillable time on print projects when compared to web projects? If so, you might want to consider revisiting your pricing model to improve your profit margin on those projects.
Hopefully these ideas will give you a great starting point for using the profit margin calculation to grow your business. In our next post, we’ll explore ways to increase your sales volume as another avenue for growth.
- Self Assessment filing for 2016/17 is live
- Making Tax Digital to be delayed
- FreeAgent Mobile - now with Bills and Estimates
- What’s it like to work at FreeAgent?
- Video: VAT accounting schemes explained by HMRC