Why Are Margin Calculations Important?

As the owner of a growing business, you have to deal with everything from daily operations to marketing to new product development. Amid all these tasks, margin calculations may not always be at the top of your priority list.

However, it’s important for every business owner to understand and be able to calculate margins, especially as your business grows. Margin calculations not only ensure your business remains profitable, but they also help your business grow at a sustainable pace.

Ready to dive deeper into margin calculations and how to calculate them?

What Are Margins?

Margins are the difference between your revenue and costs. Higher margins equal more profit, while low or negative margins are a source of concern.

There are three main types of margins in your financial reports: gross, operating and net. Each of these can be found on your income statement. 

Margins are expressed as a percentage and demonstrate how much of the revenue is kept as profit. For instance, a net profit margin of 15% means that for every dollar of revenue earned, your company generates $0.15 in net profit.

Gross Margin

Gross margin measures your company’s profitability as a whole, expressing the percentage of revenue that is kept as gross profit. It only takes direct costs into account.

To calculate your gross margin, divide your gross profit by your revenue, then multiply the result by 100 to get a percentage. 

Operating Margin

Operating margin takes into consideration operating expenses before paying taxes or interest. It expresses the percentage of revenue that your company keeps after taking into account salaries, office rent, production costs, and all other expenses.

To calculate your operating margin, divide your operating profit by your revenue, then multiply the result by 100 to get a percentage.

Net Margin

Net profit margin adds in all other revenues and expenses, such as the costs of taxes and interest. Net profit margin is often the most relevant representation of a company’s performance and profitability.

To calculate net margin, divide your net profit by your revenue and multiply by 100 to get a percentage.

Why Are Margin Calculations Important?

They Help You Understand Your Profitability

Margins are a direct reflection of your business’s profitability and efficiency. Different margin calculations can indicate different things:

• High gross margins can indicate that your products or services are priced well.
• High operating margins indicate that your company’s operations are very efficient and that costs are being well-controlled.
• High net margins indicate that your company is overall performing well and profitably.

Low or negative profit margins, on the other hand, are an indicator that something needs to be adjusted to ensure your company remains sustainable in the long run.

They Help You Set Prices

At the end of the day, every business wants to make money. Margin calculations help you do so by striking that perfect balance between competitive pricing and profitability.

Underpricing may attract lots of customers, but it could lead to unsustainable margins, causing your business to fold from production costs.

Overpricing may give you higher margins, but it can drive customers away and decrease the number of sales.

By taking time to calculate your margins, you can adjust your pricing strategy as necessary to better align with your business goals and customer needs, and stay competitive in the greater market.

They Help You Manage Cash Flow

Many startups and small businesses struggle with cash flow—the amount of money that you have available to cover expenses and grow your business.

Narrow margins can result in a business not having enough cash on hand to handle operational expenses or unforeseen setbacks and delays.

A higher operating margin allows you to improve your company’s liquidity and ensures you’re generating enough money from your company’s core operations.

They Help You Attract New Sources of Funding

At some point, every growing business will need to seek new sources of funding. Investors and lenders will look over your financials—including margins—to evaluate their potential return on investment. Healthy margins signal your company is capable of generating profits and is financially stable overall.

They Help You Identify Inefficiencies

Regularly calculating your margins can help you identify problem areas where costs are too high, or where profits aren’t enough. 

Noticed your gross margin getting smaller from month to month? That could indicate rising production costs, pricing issues or another problem. Once a problem area has been identified, you can work to make improvements to increase your margins.

What is a Good Profit Margin?

A “good” profit margin varies largely by industry. Companies with minimal staff and low overheads that sell services rather than physical products will naturally have much lower costs than brick-and-mortar stores.

For this reason, software-as-a-service (SaaS) and app companies tend to have higher margins. One NYU study found that on average, software companies’ net margins are around 20%. 

On the other hand, grocers, who must pay for rent, labor and perishable products, have very low net profit margins—on average, only 1.18%.

If you’re a growing business, you may want to consult with a financial expert to figure out what profit margins you should aim for and to understand industry-specific benchmarks.

How Can I Improve My Margins?

There are several strategies you can implement to improve your margins:

Reduce Costs

Noticed an inefficiency somewhere in the production, supply chain or operations process? Switching suppliers, automating time-consuming processes or outsourcing jobs like bookkeeping rather than hiring a full-time CFO can all help improve your margins.

Change Your Pricing Strategy

Increasing the base price of your products or services is one way to earn more profit, but it isn’t the only way. You can also consider running sales or offering discounts to get customers interested, or bundle products together to increase sales volume.

Focus on High-Margin Sales

Which products or services in your business offer the highest profit margins? Focusing your energy and marketing budget on these can lead to more sales, which will give you higher margins. If certain products are not making you a profit, consider eliminating them or modifying their price.

Retain Customers

Finding and acquiring new customers is generally more expensive than keeping your existing ones. Offering loyalty rewards, switching to a subscription model and strengthening your brand image can all help improve margins by encouraging repeat buyers.

How Can You Calculate Margins?

Accounting Software

The mathematical formulas for calculating margins can seem confusing or complex. Luckily, accounting software can help you automate the whole process. Built for startups and small businesses, accounting software is user-friendly and can automate tasks like margin calculations.

Even better, software can provide you with real-time insights into your business’s finances, letting you analyze your performance and make changes to your operations as needed.

Consult With the Experts

Many business owners and entrepreneurs find margin calculations and analysis to be both challenging and time-consuming. However, they’re too important to procrastinate on or ignore. 

Experts can streamline the process by doing the calculations for you and handling your monthly financial reports. They can also provide you with helpful insights from an external, unbiased perspective, ensuring your decisions are sustainable and make sense for your company’s future. 

Partner with Finvisor

Every entrepreneur and small business owner should understand the value of margin calculations and leverage them to help your business grow.

If you’re ready to streamline your monthly accounting and simplify the task of calculating your margins, Finvisor is here to help.

Our team of experienced professionals provides your company with solutions tailored to your needs. You’ll work with a dedicated Finvisor account manager who is an expert in handling the financial needs of startups and small businesses just like yours.

Contact us today to learn how we can help your company’s margins—and every other aspect of your finances. We’re excited to work with you!