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Benefits of Using Margin

What Are the Benefits of Using Margin in Pricing?

Do you know your gross margin? What about your profit margin? Your company’s margin indicates whether it is profitable or not. A company can have an extraordinary volume of sales, but without the proper gross margin built into the economics of the company, it results in an unprofitable business.

Start pricing your products or services to result in profit every time. Click here to download our Pricing for Profit Inspection Guide to begin.

The profit margin is the amount that sales (revenue) exceeds costs. So if your profit margin is low, then it may mean that you are making little to no money at all. Setting the correct price on a product or service is the key to profitability. You want it high enough for you to make money, but low enough for products and services to still sell.

Use margin to help you calculate exactly how much you are trying to make per unit, how much you need in order to break even, and most importantly, how efficient the company is.

Margin vs Markup

It is easy to interchange and confuse both terms of “Margin and Markup.” After all, they are remarkably similar. But when it comes to the bottom line, they are recorded and calculated different. Terminology speaking, markup percentage is the percentage difference between the actual cost and the selling price, while gross margin percentage is the percentage difference between the selling price and the profit.

For example, suppose the price of a product is $100, and it costs $80 to make. Both the markup and the margin would be $20. We calculate the profit margin percentage by dividing $20 by the $100 selling price and that equals to 20%. However, we calculate the markup percentage by dividing $20 by the $80 cost and the markup percentage would be equal to 25%.


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It is very important to remember that there are more factors that affect the selling price than merely cost. What the market will bear, or what the customer is willing to pay, will ultimately impact the selling price. The key is to find the price that optimizes profits while maintaining a competitive advantage.

Focus on the Profit Margin

A company’s main focus when it comes to pricing should be based around their profit margin. The margin measures the efficiency of a company when using their labor and raw materials in the production process. The profitability of a company relies on the established profit margin. For this purpose, a company should spend the proper time and effort to calculate the perfect profit margin for their industry and needs.

Pricing for Profit

Discover your company’s perfect price for maximum profitability. As you analyze the benefits of using margin, it’s an opportune time to also take a look at your pricing. Download the free Pricing for Profit Inspection Guide to learn how to price profitably.

Benefits of Using Margin

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Benefits of Using Margin

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Net Profit Margin Analysis

See Also:
Net Profit Margin Ratio
Gross Profit Margin
Opportunity Profit Margin Ratio
Financial Ratios
Net Income
What is Profitability Index (PI)?

Net Profit Margin Definition

The net profit margin, also known as net margin, indicates how much net income a company makes with total sales achieved. A higher net profit margin means that a company is more efficient at converting sales into actual profit. Net profit margin analysis is not the same as gross profit margin. Under gross profit, fixed costs are excluded from calculation. With net profit margin ratio all costs are included to find the final benefit of the income of a business. Similar terms used to describe net profit margins include net margin, net profit, net profit ratio, net profit margin percentage, and more. To calculate net profit margin and provide net profit margin ratio analysis requires skills ranging from those of a small business owner to an experienced CFO. As a result, this depends on the size and complexity of the company.


NOTE: Want the Pricing for Profit Inspection Guide? It walks you through a step-by-step process to maximizing your profits on each sale. Get it here!)[/box]Download The 7 Habits of Highly Effective CFOs


Net Profit Margin Calculation

For example, a company has $200,000 in sales and $50,000 in monthly net income.

Net profit margin = $50,000 / $200,000 = 25%

This means that a company has $0.25 of net income for every dollar of sales.

Steve has $200,000 worth of sales yet his net income is only $50,000. By decreasing costs, he can increase net income. In conclusion, he evaluates his decision and decides to implement the online system he was thinking about.

Net margin measures how successful a company has been at the business of marking a profit on each dollar sales. It is one of the most essential financial ratios. Net margin includes all the factors that influence profitability whether under management control or not. The higher the ratio, the more effective a company is at cost control. Compared with industry average, it tells investors how well the management and operations of a company are performing against its competitors. Compared with different industries, it tells investors which industries are relatively more profitable than others. Net profit margin analysis is also used among many common methods for business valuation.

Easily discover if your company has a pricing problem. As you analyze your net profit margin, it’s an opportune time to take a look at you pricing. Download the free Pricing for Profit Inspection Guide to learn how to price profitably.

Net Profit Margin Analysis

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Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.

Click here to access your Execution Plan. Not a Lab Member?

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Net Profit Margin Analysis

Resources

For statistical information about industry financial ratios, please go to the following websites: www.bizstats.com and www.valueline.com.

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Operating Profit Margin Example

See Also:
Operating Profit Margin Ratio Analysis

Operating Profit Margin Example

In an operating profit margin example, Bill is the founder and CEO of a retail store called Shopco. Shopco recently took a loan. Shopco has experienced a dip in sales, because of the recession, and wants to make sure they can keep net operating profit margin ratio above the limit in their loan agreement. If not, Shopco may have their loan revoked. Shopco decides to prepare for this scenario by looking at their books and finding all relevant numbers. Bill then performs the calculation below.

Revenue $ 1,000,000 Cost of Goods Sold $ 500,000 Gross Margin $ 500,000 Operating Cost $ 250,000 Interest Expense $ 25,000 Operating Profit $ 225,000 Operating Profit Percentage 22.5%

Shopco was required by the bank to maintain an operating profit margin about 10%. After performing the calculation Bill now knows that his operating profit margin ratio calculation is above this. Bill feels very relieved. He also now has the confidence to survive through his time of difficulty.

Operating Profit Margin Meaning

The meaning of operating profit margin varies slightly, although the basics stay the same across all industries. This makes it a common and important metric. Operating profit margin ratio analysis measures a company’s operating efficiency and pricing efficiency with its successful cost controlling. The higher the ratio, the better a company is. A higher operating profit margin means that a company has lower fixed cost and a better gross margin or increasing sales faster than costs, which gives management more flexibility in determining prices. It also provides useful information for investors to determine the quality of a company when looking at the trend in operating margin over time and to compare with industry peers.

There are many ways for a company to artificially enhance this ratio by excluding certain expenses or improperly recording inventory. Revenues may also be falsified by recording unshipped products, recording sales into a different period than they actually occurred, or more. Usually, it serves more as a general measurement than a concrete value.

To learn how to price for profit, download our Pricing for Profit Inspection Guide.

Operating Profit Margin Example

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Operating Profit Margin Example

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Operating Profit Margin Ratio

See Also:
Operating Profit Margin Ratio Example
Net Profit Margin
Operating Income (EBIT)
Financial Ratios
Gross Profit Margin Ratio Analysis
Interest Expense

Operating Profit Margin Ratio

The operating profit margin ratio indicates how much profit a company makes after paying for variable costs of production such as wages, raw materials, etc. It is also expressed as a percentage of sales and then shows the efficiency of a company controlling the costs and expenses associated with business operations. Furthermore, it is the return achieved from standard operations and does not include unique or one time transactions. Terms used to describe operating profit margin ratios this include the following:

Operating Profit Margin Formula

In order to calculate the operating profit margin ratio formula, simply use the following formula:

Operating profit margin = Operating income ÷ Total revenue

Or = EBIT ÷ Total revenue

(NOTE: Want the Pricing for Profit Inspection Guide? It walks you through a step-by-step guide to maximizing your profits on each side. Get it here!)

Operating Profit Margin Calculation

The operating profit margin calculations are easily performed, including the following example.

Operating Income = gross profit – operating expenses

For example, a company has $1,000,000 in sales; $500,000 in cost of goods sold; and $225,000 in operating costs. In conclusion, operating profit margin = (1,000,000 – 500,000 – 225,000)= $275,000 / 1,000,000 = 27.5%

In conclusion, this company makes $0.275 before interest and taxes for every dollar of sales.

If you want to learn how to price profitably, then download the free Pricing for Profit Inspection Guide.

Operating Profit Margin Ratio

Strategic CFO Lab Member Extra

Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.

Click here to access your Execution Plan. Not a Lab Member?

Then click here to learn more about SCFO Labs

Operating Profit Margin Ratio

Resources

For statistical information about industry financial ratios, please go to the following websites: www.bizstats.com and www.valueline.com.

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Net Profit Margin Ratio

See Also:
Net Profit Margin Analysis
Gross Profit Margin Ratio Analysis

Net Profit Margin Ratio

Using the net profit margin ratio formula, though essential, is a fairly simple process. The difficulty is taking steps every day to keep the proper financial information to calculate this and other financial ratios. Use this formula as a net profit margin calculator:

Net profit margin = Net income ÷ Total revenue

Financial calculators exist which can simplify the process of net profit margin calculation.

Net Profit Margin Example

For example, Steve owns a sole proprietorship which provides tech support services for small businesses. His company, serveco, is succeeding and making Steve a living wage. Steve has recently earned as many customers he is willing to handle. He now wonders if he can increase company profits while maintaining all other aspects of his business. He has considered implementing an inexpensive system to access client’s computers online instead of visiting their office. Steve, though not a CPA, is a very competent man. He begins by searching Google for “net profit margin ratio calculator” and eventually finds the information he needs. Steve converts his company records to Quickbooks. His result is the calculation below.

Because companies come in all different shapes and sizes, it is natural to observe that their net profit margins would differ as well. In fact, businesses can have a profit margin of as high as 19% or as low as 5-10%. As one would expect, the companies with the higher net profit margin are the ones that are the best organized. The companies that are the best organized are the ones that are the most efficient. The ones with the least amount of profit margin are, by contrast, the companies that are the least organized and efficient. Though, it must be said though that the ratio can be good or bad for industry that a business is in. For example, a 10% net profit ratio could be good for one industry and bad for another.

Net Profit Margin Rule

As a general rule of thumb, businesses should strive to maintain a net profit margin ratio that is above the average for the industry a business is participating in. At the same time, the business should also try to maintain a trend with that ratio that is improving, at least slowly, over time. Furthermore, a company can maintain a low ratio by finding ways to reduces expenses.

To learn how to price for profit, download our Pricing for Profit Inspection Guide.

Net Profit Margin Ratio

Strategic CFO Lab Member Extra

Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.

Click here to access your Execution Plan. Not a Lab Member?

Click here to learn more about SCFO Labs

Net Profit Margin Ratio

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Lower of Cost or Market (LCM)

See Also:
Accounting Principles
Accounting Concepts
Generally Accepted Accounting Principles (GAAP)
How to manage inventory
Inventory Cost

Lower of Cost or Market (LCM) Definition

Lower of cost or market accounting is generally based off of the accounting concept conservatism. It generally states that certain accounts should be stated at their historical costs or market costs whichever is lower.

Lower of Cost or Market (LCM) Meaning

The lower of cost or market means that accounts like inventory will often show unrealized gains or losses depending on how historical costs and market costs relate to each other. This means that if the market is lower than what it cost the company to produce a product, then the company is operating at an unrealized loss. The Gross Margin may be higher, but the true and actual costs to the company are higher. If it is the other way around the company will be operating at an unrealized gain in which the company’s historical costs are lower than the market. It should be noted that the market cannot exceed the sales price and likewise it cannot be less than the profit margin that a company would realize.

Lower of Cost or Market (LCM) Example

David is responsible for the accounting of inventory for Wawadoo Inc., which specializes in the production of widgets. After careful analysis David finds that the costs to the company to produce a widget cost $10 a piece. However, market conditions have worsened over the past few months, and the value of the inventory on hand is now only equal to $8 a piece. Therefore, David must write down the inventory on Wawadoo’s books by $2 for every widget in stock. Note that if you were selling these widgets for $12 then the company was producing a gross margin of $2. However, with the reduction in market cost many of Wawadoo’s competitors will drop their selling price. Thus Wawadoo must drop its price as well. If Wawadoo were to drop its selling price to $10 the company would be operating at breakeven because of the current inventory on hand.

lower of cost or market

 

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Cash is in Your Business

See Also:
Cash Flow After Tax
Cash Cycle
Financing A Startup Company
How to Collect Accounts Receivable
Monetize
How to Develop A Daily Cash Report
Cash Flow Statement

Cash is in Your Business

I received a call from a desperate prospect, Sue. As always, I started asking questions about the business. To begin, I asked “Is your business growing?” She answered “Yes”. Then I asked her “What does your business need?” Frustrated she answered I NEED CASH. My next question was “Why do you need the cash, Sue?” Frustrated more than ever she replied “TO PAY MY BILLS!”

Two Sources of Cash

Seeing I was about ready to lose her in frustration I ask “Where does the cash come from in your business?” She responded calmly “What do you mean?” I responded there are two sources of cash for your business; internal and external. I continued by telling her we need to understand the cash source to determine and solve the problem. That is the only way we can ultimately get you the cash in the most cost effective way to satisfy your needs, paying your bills.

She then said “I still don’t understand your comment about internal and external?” I told her that internal cash flow in a growth business is generated by selling your goods or services at a profit. I then asked her what she sold in her business. She told me she manufactured products and sold them to large retail stores. I asked a couple more questions about her profit margins and satisfied myself that her margins were more than adequate.

A/R Collections

Then I asked her about her accounts receivable collection efforts and inventory management. She asked me “Why would you care about that?” Not waiting for a response she continued “I think I need a larger line of credit from my bank and they do not seem to be interested.” Increasing your line of credit with the bank may not be the most cost effective way to solve your cash flow needs. I asked her again about her accounts receivable collections and inventory management. Reluctantly, she told me that her receivables are past due, she is at her maximum credit line with her suppliers, and she does not have inventory controls.

Now that I understood her situation, I showed her that speeding up her accounts receivable collection process, and managing her inventory would allow her to get her suppliers back within their credit terms, and pay down her line of credit at the bank. The combination of these three results gave her the operating capital she needed to continue her growth for an estimated six months. Therefore, we could pursue external cash sources without the pressure of having to make a decision today. Start with knowing that cash is in your business.

For more tips on how to improve cash flow, click here to access our 25 Ways to Improve Cash Flow whitepaper.

cash is in your business, Sources of Cash
Strategic CFO Lab Member Extra

Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.

Click here to access your Execution Plan. Not a Lab Member?

Click here to learn more about SCFO Labs

cash is in your business, Sources of Cash

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