If you own a business, monitoring your profit margins regularly will give you the valuable data to identify the most lucrative areas of your business and scale them.
"Understanding your profit margins is particularly essential in navigating volatile times," says Claude Compton, founder of Pave Projects, a London-based hospitality group. "Having a deep understanding of your profit margins allows you to be adaptable and pivot at speed, while providing proactive leadership and fact-based decision making."
For UK private non-financial corporations, the average profit margin was 12.3% in the first-quarter of 2019. For manufacturing companies, it was 12.2%, and 19% for service companies. While this is a useful reference, it's important to remember that margins vary by industry and company size. Here's a look at how to calculate your own margins and why it's important to do so.
What is a profit margin?
Profit margins measure the money your business makes from selling its products or services minus the costs incurred in delivering that sale. Two common measures are the gross profit margin and net profit margin, which are both expressed as a percentage.
The gross profit margin measures the money left from the sale of your goods or services, once the direct expenses used to generate them are deducted (eg. labour and material costs). It varies across products and sectors, and is often used to measure the profitability of a single product.
Net profit margins go further, looking at the profit to your business after all overheads have been accounted for, such as taxes and operating costs.
Why are profit margins important?
Your profit margins indicate how well you are using your resources to make and sell your product or service. A high margin generally indicates you're making money on a product, whereas a low margin means your sale price is not much higher than the cost.
A strong understanding of your margins allows you to make quick decisions to support the growth and resilience of your business. For example, a spike might indicate a new trend that warrants additional investment, whereas a decline might highlight rising expenses, prompting you to analyse your cash flow and make cuts where necessary.
"We look at gross profit margins and specific key performance indicators in real-time daily and review in more detail on a weekly basis," says Compton. "This regularity allows the business to ride-out changing tides and isolate any issues before they become a long-term problem."
As an example, by analysing your margins, a business will be able to pin-down related price increases due to unexpected economic disruptions.
How to calculate gross profit margin
To calculate the gross profit margin on a single product, start with the revenue you earn, then deduct the costs incurred in production. Divide gross profit by the revenue, then finally multiply by 100.
As an example, a shoe-maker might sell a pair of shoes for £50. They cost £15 to make, yielding the retailer a gross profit of £35. This equates to a margin of 70%.
Total product revenue: £50
Total production costs: £15
Gross profit: 50-15 = £35
Gross profit margin: 35/50 x 100 = 70%
How to better manage your profit margins
Monitor your profit margins regularly
Compton undertakes a weekly review of his profit margins. "For this year, it has allowed us to steer the business through by isolating cost-cutting and revenue-driving areas, necessary to avoiding losses in a very challenging year for hospitality." For example, to boost revenues, Pave Projects implemented specialised technology to increase the speed-of-service.
Use profit margins as a tool
Profit margins are a retailing tool. "You can flex your gross margin to sell old stock, increase footfall and increase loyalty," says Andrew Goodacre, CEO of the British Independent Retailers Association. For example, some retailers deliberately create "loss leading" products by keeping margins low, with the expectation of selling customers other more profitable items, he says.
Build them into your business model
A common reason for low profit margins is the business model, says Goodacre. But this isn't always a negative. Low-cost retailers such as Lidl and Aldi deliberately run low margins but with low overheads. Conversely, Waitrose operates higher margins in return for a higher perceived quality.
Keep a long-term record
By regularly tracking your margins, you're growing a valuable pool of data that you can use to analyse performance over time and across markets. This can help you to understand the customer market that your business is attracting, says Goodacre. For example, by enabling you to spot whether a product is more profitable in one market over another or at certain times of the year.
Understanding your margins helps you to better manage your cash flow, ensuring there's always enough money to pay your suppliers and expenses on time. The American Express® Business Card has a 54 day payment period, giving you more control over your cash flow and when you make your payments¹. Find out more here.
- The maximum payment period on purchases is 54 calendar days on Gold & Platinum Business Charge Cards and 42 calendar days on the Basic Business Charge Card, it is obtained only if you spend on the first day of the new statement period and repay the balance in full on the due date.