Increasing profit is one of the main goals of any business, but how exactly can this be achieved, and what is important to consider? We help you understand what margin and profitability are, and how these indicators can help you increase revenue and control costs.
We provide financial consulting services for your business. We help you understand key financial indicators and develop a strategy to achieve maximum profitability.
What is margin?
Margin is the difference between revenue and variable costs. It shows how much you earn from each sale and is measured in absolute terms.
Margin = Revenue - Variable costs
For example, if you sell a product for 200 lei, and its cost is 120 lei, the margin is 80 lei (200 - 120 = 80).
What is profitability?
Profitability is calculated as the ratio of the margin to the total revenue and is expressed as a percentage.
Profitability (%) = (Margin / Revenue) * 100%
The higher the profitability, the more efficiently the business operates. A high profitability means that the company generates more profit for every monetary unit earned, allowing for covering expenses and investing in development.
There is no single universal benchmark for profitability suitable for all industries and types of businesses, as the optimal level of profitability depends on numerous factors, including industry specifics, competition, cost levels, and company strategy.
Profitability levels vary significantly across different sectors of the economy:
– Retail. Here, profitability often ranges from 2% to 5%. Competition is high, and operational costs are generally significant.
– Manufacturing. Profitability can be between 10-20%, depending on the product and production efficiency.
– Technology companies. They often have high profitability – up to 40% or more, especially if they work with software, where production costs per unit are minimal.
– Services sector. It can have profitability between 15-30%, as services often do not require significant production costs but are highly dependent on staff qualifications and other operational expenses.
– Manufacturing. Profitability can be between 10-20%, depending on the product and production efficiency.
– Technology companies. They often have high profitability – up to 40% or more, especially if they work with software, where production costs per unit are minimal.
– Services sector. It can have profitability between 15-30%, as services often do not require significant production costs but are highly dependent on staff qualifications and other operational expenses.
Profitability is considered good if it allows covering all operational expenses, investing in development, and ensuring an acceptable profit. Thus, a "good" profitability indicator should be evaluated in the context of the specific business and industry.
Example of profitability calculation
Let's say your business earned revenue of 500 000 lei in a month, and variable costs amounted to 350 000 lei. To calculate profitability, we use the formula:
Profitability (%) = Margin / Revenue * 100% = (500,000 - 350,000) / 500,000 * 100% = 30%
So, the profitability of your business is 30%, which means that out of each earned leu, 30 bani represent your net profit.
How to increase margin and profitability?
To increase margin and profitability, you need to focus on two key factors: increasing revenue and reducing costs.
Let's look at some strategies to achieve this goal:
- Cost optimization. Try to reduce production costs, improve raw material procurement conditions, or find cheaper suppliers. Optimizing logistics and improving production processes can also help reduce costs.
- Price increase. If your product or service has unique qualities or you have a loyal customer base, you can increase the price. However, remember that raising prices can negatively affect demand, so it's important to evaluate the market situation correctly.
- Increase average order value. Encourage customers to buy more at once. You can offer product bundles, bonuses, or discounts for purchasing multiple items. Increasing the average order value allows for higher revenue without attracting new customers.
- Focus on high-margin products. Analyze your product range and identify which products or services bring the most profit. Focus on promoting these products and try to increase their sales.
- Increase sales volume. Expand your market, launch advertising campaigns, and attract new customers more actively. The more sales, the higher the overall profit and profitability of the company.
- Process automation. Implementing automation in business helps reduce labor costs, minimize errors, and increase efficiency. Automating production and management processes helps reduce costs and increase profitability.
Why are margin and profitability important for business?
Margin and profitability are key financial indicators that allow you to evaluate the efficiency of your business and understand how profitable it is. Understanding these indicators helps in making informed decisions regarding pricing, cost reduction, and company growth.
Thus, a high margin allows the company to accumulate capital faster for further growth, while high profitability reflects stable operations and the business's ability to generate profit. Regular analysis of these indicators helps identify weaknesses, adjust the strategy, and ultimately improve financial results.