When the going gets tough, the tough check their margins
2022 had its ups and downs. And with the inflationary waves that are rippling through the economy, it looks as though 2023 will present some challenges. Businesses across the UK are searching for ways to shore up their supply chains and manage their costs. As people tighten their belts further, the impact will be felt by everyone, regardless of whether you’re B2C, B2B, large, or small.
Of course, this perfect storm of world activity has many implications, but where businesses feel it most is in their profit margins. And it’s going to require some steadfast discipline to maintain a positive bottom line.
But what will this entail? Profit is something we’re all familiar with, but to protect your profits as a business owner you will need to clearly understand what your ‘profit margin’ is, so you can take the steps you need to take.
What is profit margin?
This may be obvious to a seasoned business owner but it’s worth clarifying.
Profit margins are a key measure of the financial health of your business. Where cashflow keeps your business running, profit margins are the slice of your output that make it all worthwhile. It is your profit margin that puts extra money in your bank, above what you spend to produce products and services and run your business.
There are three main types of profit margin – gross profit margin, operating profit margin, and net profit margin. Each one is expressed as a percentage and is calculated using different variables in your business.
The first, gross profit margin, is simply your overall gross revenue minus the cost of goods used to make your products. It does not include costs such as administration costs. The second, operating profit margin, looks at revenue and deducts the cost of goods, but it also deducts admin costs and sales expenses, plus it may also account for certain asset depreciation; it doesn’t include taxes and other non-operational costs. And the final one, net profit margin, gives you a proper indicator of your bottom line, for it also takes into account income from other sources and all your expenses, including taxes.
What do your profit margins actually tell you?
In their way, each one tells you how much of what you’re bringing in is actually adding to your bottom line. Let’s face it, it sounds a whole lot better to hear that 90% of your efforts are converting into additional cash rather than just 5%, eh? And that’s what a percentage profit margin tells you.
Different businesses naturally have different healthy profit margins. For example, a successful consulting business may easily be enjoying a profit margin of 100% or more, whereas a booming restaurant might be as low as 10%. So, benchmarking for your industry is critical to understanding how well your business is doing in the scheme of things.
How can you improve your profit margin?
With the tough months ahead, planning to grow through increased sales volume may not be achievable for a while. Thus, what should an ambitious business owner do to maintain a healthy bottom line? Putting your effort into increasing your profit margins rather than your revenue may be the answer.
To achieve this, you’re going to need to get disciplined on a few key areas of your business.
- Make a point of tracking your expenses. If you don’t know where your money is going, it’s going to be hard to shave off some outgoings and cut costs.
- It’s possible for your gross profit margin and your operating profit margins to be pretty healthy, even if your business is struggling on the bottom line. This means you need to keep an eye on your net profit margin. The influencing factor in this case could be non-essential overheads. However, if your operating profit margin is struggling, you’re going to need to get to grips with your operating costs. So, take a close look at everything from your monthly subscriptions to your coffee invoices… and cut back where you can.
- Consider increasing your prices. In a time of inflation, it won’t be a surprise that you’re doing this. However, bear in mind that to increase your profit margin you’re going to need to increase your prices by more than your suppliers are increasing theirs. So, the final price tag you set may price you out of a very competitive market.
- Take steps to re-negotiate some of your supplier contracts. They won’t be surprised and may be eager to keep you happy by offering you a better deal. Perhaps, if cashflow isn’t an issue, ordering more of a product to get a bulk discount may serve you well. Though you don’t want to be storing too much if you’re not sure you can move it through the business within a reasonable time.
- Drill down on your marketing and advertising. Focus specifically on the channels that work well and stop worrying about trying to catch a few outliers here and there. Making your marketing more effective is a good habit to get into and will serve you very well once things pick up again.
All of this may seem a bit daunting if you’re not familiar with the jargon and maths, of course. And that’s understandable. If you were a whizz with figures you may well have chosen to build an accountancy business rather than set up in the industry you’re in.
Successful SMEs are good at what they do because they focus on their core strengths and bring in trusted advisers to deal with the necessary parts of running a business they know less about. That’s often where Essendon come in. We work with our clients behind the scenes, providing proactive advice and keeping track of the figures, which leaves them free to do what they’re best at… grow and thrive in their market.
So, with that said, let’s all look forward to what 2023 holds and support each other as the year unfolds. Good luck and don’t lose sight of your profit margins. You’ll be pleased with the results in months to come, we’re sure.
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