The Highs and Lows of Profit Margins
If you’re running your own business you’ll be only too familiar with the concept of ‘margin’ – the difference between a product’s sales price and the business’s cost of acquiring and maintaining the product prior to sale. In broad terms, a high profit margin indicates that a company operates efficiently while a low profit margin typically indicates a highly competitive market or an ineffectively run business.
Running at a low profit margin exposes the company to several risks:
Hindrance to Growth
It doesn’t take a genius to work out that if you have a lower gross margin you will have less money available to you. Less money to invest in IT systems or marketing, less money to employ more staff or train those you have, less money to pursue other markets or acquisitions. Over a long period of time such shortfall will result in your competitors stealing the advantage.
Pressure to increase sales
In order to achieve higher margins one solution is to increase unit sales, but putting increased pressure on your sales staff risks de-motivating them and therefore open to looking elsewhere for jobs. Your team is one of your greatest assets – value them and try to find another way, such as implementing innovative marketing programmes combined with refinancing so that the cost of paying contractors is as low as it can be. Trying to negotiate with your contractors to pay them less is a possible option but not always viable.
Lower Company Worth
Generally speaking, a lower gross margin company will have a lower net profit as a percentage of sales than a similar company with higher gross margins. If you’re thinking of selling your business, your company will be less attractive than one with higher gross margins. If you have an eye to your exit strategy you need to bear this in mind early on.
Help is at Hand!
Before you decide you may as well close your doors now, talk to an accountant experienced in looking at the big picture. Give them access to your accounts and talk them through the situation you find yourself in. Remember they are on your side and want the best for your business! It could well be that they can suggest ways forward you haven’t seen.
First of all, your accountant will be able to help you analyse your profit margins. Your overall gross profit margin could be deceiving. Take the time to look at your gross margins over different product lines, suppliers or customer segments. You will end up with a clear picture of what products or services are lowest or even loss-making.
Armed with that knowledge, you, together with your accountant, can run through a number of “what if” scenarios. You may be surprised to see that, for example, a 10% increase in your sales price could bring a 50% increase in profit! The following are just a few changes you could implement to improve your gross margin:-
Focus on High Margin Services and Products
Eliminate, or reduce your efforts on, low margin lines and concentrate on those bringing the most reward.
Increasing your Sales Price
I can imagine you wincing at this idea but most customers are aware that overheads go up all the time. Making a marginal increase might lose you one or two customers but, assuming you are not dependent on just a handful of customers (see our earlier blog Over-Reliance on Too Few Customers), a small increase could make that crucial difference.
Discounting makes significant inroads into your margins. Drop your discounting and you will see an immediate increase in your profit margin.
Making staff redundant is a common reaction when faced with low margins but bear in mind that presumably that person added some value to the organisation and someone else will now have to pick up that job. Staff morale – and therefore possibly productivity – is likely to fall, possibly negating any cost savings achieved.
It may take time, but with good management your company could be soaring to a new high, at least where your profit margin is concerned!