When we create a business, more than the dream of having autonomy and developing something according to what we believe in, we intend to make this activity one. And the profit margin is used to measure the profitability of a product, service or business, which will help us to know how profitable our own business is.
In order for this to work without errors, it is essential to understand some basic concepts, so that all the work turns into something that is financially profitable. And one of the main concepts in this universe is the profit margin.
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Do you know what it is and how to calculate the profit margin of a product? We will tell you everything below. stay tuned!
Discover the types of profit margin
To understand the concept of profit margin it is necessary, first, to know what profit is. In general, the profit corresponds to the positive return that we obtain from a certain investment.
However, within the business universe, in addition to understanding this meaning, it is necessary to differentiate the concepts of gross profit and net profit.
1. Gross profit
It corresponds to the final value obtained after the sale of a product, subtracting from this value the costs used in its production.
If you sell a product for $15,000.00 and the materials used in its production cost $8,000.00, your gross profit is $7,000.00.
2. Net profit
The net profit corresponds to the result of the subtraction of the final value less all the general expenses of the company. In this case, we include taxes, charges, electricity, internet, water and other services in the value.
In the example above, if these values add up to $2,000.00, the net profit from the previous trade would be $5,000.00.
What is the profit margin and what elements make it up?
We consider, then, the profit margin as the percentage that we add to the total cost of the product, which defines the price for which it will be marketed to the customer. Of great importance for the success of a business, this is fundamental for the formation of the prices of products and services.
We can divide this margin into three main elements, these being the costs, the sale price and the profit:
1. Costs
As you might imagine, they are the values involved in the production of what will be sold. This concept includes elements such as taxes, freight, water, electricity, telephone, internet, labor charges, and others;
2. Sale price
It is essential to the success of a business. The ideal is to balance the costs and, at the same time, compare the prices charged by the competition;
3. Gain
Corresponds to the percentage that the business receives on the sale of a product.
How to calculate the profit margin correctly?
Calculating the profit margin is critical to the success of any business. So, you need to be aware of the three concepts involved in this scenario: Net Margin, Gross Margin, and Markup.
It is these margins that help analyze the profitability of a business, making it easier for the entrepreneur to understand which sector or product is better.
The first step to calculating these error-free margins is to understand the need to do this for each product or service in your business. There are not a few entrepreneurs who make a general calculation and obtain a positive result, leaving aside the analysis of non-profit products.
Based on this assumption, you can use the three concepts that we will explain below to analyze your business efficiently and efficiently.
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1. Net margin
As the name itself says, the calculation of the net margin is done according to the net profit of your product. To do this, just divide the net profit by your total recipe and multiply the result by 100.
Following the example above, we have:
$5,000.00 / $15,000.00 x 100 = 33.3%
This means, then, that the net profit margin is 33.3%.
2. Gross margin
On the other hand, the gross profit margin is calculated in the same way, but substituting the value of the net profit for the gross profit obtained on your product.
Thus, for the example shown, we get:
$7,000.00 / $15,000.00 x 100 = 46.6%
In this case, the gross profit margin is 46.6%.
What is Markup and how is it related to profit margin?
Last but not least, we have the Markup. This is a fundamental element in the search for sustainable business growth and is, at the same time, one of the most unknown to the general public.
Its difference for net and gross profit margin is that it also takes into consideration the profit desired by the business.
And it is for this reason that the Markup is fundamental in the stage of the products, since it facilitates the visualization of the possibilities of prices to be charged.
There are three types of Markup that we detail below.
1. Full Markup
In this calculation, all the costs of the business are included, from taxes to expenses with supplies and personnel. The account is made by dividing the desired gain by the total cost.
2. Product Markup
Calculating the Product Markup is a more specific task. In this case, it takes into account only the costs involved in manufacturing the product, similar to what we do with gross profit.
The difference is that the account includes administrative and sales services, in addition to the desired profit.
Thus, the result is obtained by dividing the sum of the desired profit plus administrative and sales services by the cost of manufacturing the product.
3.Variable Markup
Finally, the variable Markup weights the fixed costs and services. The result corresponds to the ratio between the desired profit plus costs and fixed services for variable costs and services.
Other variables that you should consider in the calculation
Analyzing the possibilities to calculate the exposed profit margin, this task may seem simple to do, right?
However, it is essential to check some variables so that the sum is perfect.
The remuneration of employees and the seasonality of inputs, for example, are essential factors that completely alter the values dedicated to the cost of production.
The ideal, in this case, is to average these expenses over a period and calculate your margin on that.
Another important point is to analyze the entire sales cycle of your product. All investments made, from product disclosure to after-sales procedures, must be used as elements that help compose the final price. Otherwise, you will probably have a loss in your business.
As essential as knowing your profit margin is knowing what return you will have after so many investments.
So, nothing like monitoring one of the most important metrics in the market: ROI. Be sure to check out our article where we explain!
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