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A profit margin is the basic means of small business accounting to gain insight into how much money your business is making, the general health of your business, and the problems within your business. Therefore, all small business owners should consider this metric: the profit margin. Profit margin is calculated on the percentage of sales that have turned into profits, i.e. dividing the net income by sales.
There are times when you don’t meet the profit expectations that you have set for your business. At times like these, you need to know why the profit margin is below expectations and make necessary adjustments in your business functions. If you want to know how to troubleshoot your profit margins, here are some of our tips to consider.
Gather Insights and Analysis from Annual Trends
Let’s start with looking at the income statements from the past years of the business. Look for the things that were driving the profits each year. Were there any seasonal surges or a pause in the statistics? How did the product perform in the respective years? Did increased competition affect your sales? Was there any poor execution of sales strategies? Performing this analysis and getting answers to these questions can help you drill down to the reason for stopping the sales of your products or services. Brainstorm the solutions to reduce the impact if the same circumstances still occur and affect your performance.
Compare Yourself to the Competition
Knowing how to stack up to the competition shows how well you are doing and decide your future strategies. Look up at your competitors and compare the profit margin of your competitor. When you compare your business strategies - such as marketing, targeting, and providing customer services - with your competitors, you re-analyze the root causes of the problems that are becoming an obstacle in your sales. Make a note of all the things that you like about your competitors that are also working well for them, and look for ways to inculcate the same in your business functions.
Consider Re-pricing Your Products
There is a possibility that your business is doing more while maintaining equivalent overhead expenses. To increase your revenue strategy, you need to choose a low-price strategy, i.e. reduce your selling price to increase revenue. By using this strategy, you should see a pick-up revenue assuming that your customers are price-sensitive. For instance, a car manufacturer that produces luxury cars will sell fewer models because of their high price tag. The strategy is to raise the prices and sacrifice the volume and operating costs by making more money on every sale.
On the other hand, the car manufacturer with economy cars will make less profit margin but can sell more cars since their customers can afford the price. Both the strategies are effective, but the execution of these strategies depends on the type of business and your customer’s tolerance level.
Here is how you can determine the price of the product:
For example, if you need to make a 15% profit on a product with the selling price of CAD 18, you need to subtract the profit percentage that you want from 1. Let’s say the factor is 0.85 (1-0.15). To calculate the selling price of the product, divide the original cost (18) by the factor 0.85. Therefore, you need to sell the product for CAD 21.17 to receive a 15% profit margin for your business. You can talk to your business’s financial analyst and small business accounting expert to price the products rightly.
When you know your profit margin, you can uncover your spending practices or make decisions to cut costs in certain areas. It is all about keeping overhead costs as low as possible to produce a quality business product. The formula of the cost of goods sold for small business accounting is:
Beginning inventory + purchases during the period - Ending inventory
You can reduce inventory costs by purchasing in bulk, taking advantage of supplier discounts, and negotiating terms with the suppliers. Try to cut back the cost of goods sold to the extent that it positively affect sales.
Cut Underperforming Products or Services
Making this call is completely yours. If you have certain products that are not doing well in the market, try to pull them out of the market. This might help you trim the cost, and you can use that cost to bring up the profit margin percentage. You can even reduce your staff members if the salary is becoming a considerable expense item in your small business accounting books.
Review Profit Margins as Monthly Practice
As a small business owner, you should always know how your business is spending money. It is important to improve your profit margin to track the expenses. A well-run business looks at the numbers in their small business accounting monthly. All successful companies go through this necessary exercise. If your numbers are different from one or two percent, that is not significant and can be controlled. But when the numbers differ by five percent or more, then it indicates that there are things that need to change. Analyzing the margins is a great diagnostic tool for monitoring the health of your business.
Consult a Professional
Sometimes, you can’t identify the core issues to troubleshoot your profit margins no matter how many strategies you use. If you are still baffled about why profit margins aren’t where you thought they would be, try consulting a professional small business accounting expert. An outsourced small business accounting firm can bring your objective view of the situation and identify the core issues of the problem.
Remember that profits are nice, but the margins are even better. Do your research and make sure you track the numbers down to every last expenditure and revenue source. Knowing where your small business accounting is along with your profit margin will help you determine where to go next.