Imagine your business as a living, breathing organism. Just like we monitor our vital signs to ensure health, we need to monitor our business’s vital signs to ensure it’s operating at a top level. So, today, in five minutes or less, you will learn how to maximize business health by increasing your profit margin.
Here, we will confine our minds to three basic topics as follows:
- Understand profit margin
- Case study on increasing profit margin
- Strategies for boosting profit margin for maximizing business health
Understanding Profit Margin
What Is Profit Margin?
Profit margin is a percentage of net income to total revenue. It measures your ability to make money. The percentage represents how much of the total sales you keep as profit. It’s not just a number on the paper; it’s a vital sign for your business and for your personal finance strategy.
Think of it as your temperature. Just like a doctor monitors ours to ensure we’re healthy, we must monitor our business to ensure its health.
Our businesses thrive when profit margins are robust. Profit margins are the lifeblood of growth and survival, ensuring we can continue on the journey.
Tracking this number will alert you early of trouble on the horizon. This empowers you to diagnose and fix the issues before they spiral out of control.
Factors Affecting Profit Margin
- Gross Revenue: It is the total income you bring in.
- COGS (Cost of Goods Sold): The cost of labor and materials related directly to your production.
- Operating Expenses: These are all the expenses you incur to operate your business. They include rent, equipment, inventory, marketing, payroll, insurance, and any other expenses.
- Profit: It is what you have left after all expenses are deducted from your gross revenue.
Common Pitfalls To Avoid And To Increase Business Health
- Unnecessary expenses
- Too few or too many employees
- Inaccurate pricing (prices that are too high or too low)
- Not monitoring financials
Case Study
HomePro Solutions
HomePro Solutions is a high-quality home renovation and remodeling company that’s been in business for 15 years.
Alex started the company when he was 22 and built a $1.8 million business. He has 8 employees, and now that he’s started a family, he wants more time to coach his kids’ sports teams and spend time with his wife.
He’s pretty sure he’s making money, but he’s been so busy in the business that he’s never stopped to figure out the numbers.
Here’s the information Alex needs to find out what his profit margin is:
- Gross Revenue: $1,800,000
- COGS + Operating Expenses: $1,602,000
- Net Income: $198,000
Here is the equation to calculate the profit margin:
Net Income / Gross Revenue = Profit Margin
$198,000 / $1,800,000 = 0.11
So, Alex has a profit margin of 11%.
Having owned a landscape company for 8 years, any experienced person would suggest that a healthy margin to maximize business health for a home service company would be 30%.
This is the number you should always aim for. Usually, something closer to 25% would still be good. If you’re operating below 10%, you have so much room for improvement.
Alex has $198,000 in profit. Here’s how he likely distributes it:
- $60,000 into new equipment
- $10,000 in employee bonuses
- $20,000 in operating capital
This leaves $108,000 in Alex’s pocket. The good news is, he’s making money!
Some businesses aren’t so lucky. You can operate at a negative cash flow for years and never notice it as long as you have continuous income.
As soon as something happens that causes incoming business to decline, businesses will find themselves in a hurting situation pretty quickly. This is how businesses fail.
When the tide goes out, you’ll see who’s swimming naked. So, what can Alex do to reduce his time at work to spend more time with his family?
He can boost his profit margin, which will allow him to afford to hire somebody to fill his role in the company.
Strategies to Boost Profit Margin for Maximizing Business Health
Here are three simple steps to increase your business margin and ultimately maximize your business health:
- Increase Prices to impact your bottom line directly.
- Decrease Expenses and find where you can cut costs without sacrificing quality.
- Streamline business operations, automate tasks, and improve workflows so jobs get done more efficiently.
Final Thoughts
Understanding profit margin as a key business vital sign allows you to proactively monitor its health and identify areas for improvement. Just as a doctor diagnoses and treats a patient based on vitals, you can diagnose and address weaknesses in your business using profit margin data. Implementing strategies like price adjustments, cost reduction, and operational streamlining can elevate your profit margin and maximize your business health in the long run.
How to Maximize Your Business Health Through Profit Margin