Sales margin is one of the most important indicators of the level of success you’ve achieved with your business. It shows how much money you’re actually making, as its name suggests, on everything that you sell. It’s really a simple calculation, one that doesn’t require the use of any sophisticated software or tools to arrive it, but it’s a crucial one to keep a careful eye on. The higher your sales margins are, the more you’re making, and the more potential for higher profit moving forward. It also helps you understand which products are your biggest moneymakers.
In small businesses, especially young companies in a growth phase, much attention tends to be focused on increasing revenue, and quite rightly so. Revenue equates to cash, and, of course, that’s what you need for, well, for everything you need to do to further the growth of the business. Ultimately, however, it’s more important to be concerned with your actual sales margin, often referred to as gross profit margin, because it relates more directly to your bottom line, which is what you really want to see increasing. Interestingly, an analysis of the numbers shows that sales margins are generally more of a function of the prices at which you buy your products, rather than the prices at which you sell them.
Calculating the Sales Margin
The first step in figuring out your sales margins is to choose a time period that you’re going to look at. This may be monthly, quarterly, semi-annually, or annually. You can choose any time period that you wish, but if you’re trying to do comparisons (to understand which products are the most profitable) it’s important to keep the time frame consistent.
Expressed very simply, your sales margin is the difference between your cost of sales, and the retail prices at which you sell your product. Taking that difference and dividing it by your retail price results in your gross profit margin, expressed as a percentage.
OK, but what’s my cost of sales?
There’s no mystery to “cost of sales”. It’s just that: the total of all the costs involved in producing your product or services. It’s going to be somewhat different based on what you’re selling. If you’re a consulting company, your cost of sales is likely to be relatively low, yielding higher sales margins. If you’re in a retail business like a supermarket, cost of sales will be relatively high, resulting in thinner sales margins
Consider your cost of sales to be the price you pay for the products you sell, including shipping cost, or the raw materials needed to make those products, if you’re in a manufacturing or assembly business. You’ll also need to factor in all of the relevant labor costs (for manufacturing, assembly, and sales), as well as other fees and expenses and reimbursement to the people who sell your products.
What can I do once I know my sales margins?
OK, this is a simple enough process, but once the calculations are done, what can be done with that information? The main point is to determine which of your products result in the highest sales margins. Once you know that, you’ll have some choices to make. Ideally, for products yielding low sales margins, you’re going to want to change something: reduce production costs, or increase your price. If neither of those can be accomplished, you may want to consider discontinuing that particular product.
However, in the real world, things aren’t always that clear cut. You can’t necessarily restrict yourself to only selling the products with the highest sales margins. In reality, it may be your “loss leaders” that get customers in the door, and may even be the products that define your company’s identity.