When measuring business success, many people will look at the sales, and leave it at that. However, success is not just about sales. A critical element in the success of your business, is your margin which leads to profits.
What is your margin exactly?
In the simplest of terms, it is the difference between what something costs for you and how much you charge for it. Margins can be shown in percentages and $.
A successful business owner will protect their margin rate above all else. Having a high-profit margin is a key step to ensure financial success, and avoid a place where you find yourself working hard, only to break even.
I’ve seen business increase their total sales, but end up making less money because they didn’t protect their margin. There are a few reasons for this. Maybe they chose to sell their products at a discount to achieve more sales, or they let costs creep up while they were busy selling their product or service.
Below is an example of what I mean. In scenario one, you sell $1,000, and in scenario two you sell $1,200. Making more money sounds better right? But as you look deeper, that may not be the case.
You sell 10 dresses
You decide to mark prices down a little to help bring in more sales. In this scenario, you sell 15 dresses for $80 each resulting in sales of $1,200. Your costs are still $50 per unit, so in this scenario, your profits only amount to $450 (1200 – 750), a 37.5% margin rate.
Even though you sold five more units in scenario two and incurred $200 more in sales, your margin rate was lower. At the end of the day, your profits are actually less.
Offering a discount is a huge incentive for many buyers. However, you’ll want to know your break-even point when discounting your products so at the end of the day, you will still succeed!
Setting Your Prices
It seems like many business owners struggle to set their prices. They’ll often look at the competition as a guide for pricing, without calculating their own costs. One person might be spending more producing a product then the other, which would greatly alter the overall margins.
When it comes to setting prices for your products, make sure you take into consideration everything that goes into your costs of goods. According to Investopedia, the cost of goods is defined as: the cost of the materials used in creating the good along with the direct labor costs used to produce the good.
It’s important to keep accurate records of how much you are spending on materials for your product as well as the labor for creating it. Whether you are doing everything yourself, or have help, the cost of your time is still of value.
Forecasting sales is a great way to buy in raw materials (or finished goods) in larger quantities, which may help reduce costs and thus increase your margins.
But what about service businesses?
The same holds true when pricing your services. While services might not be tangible, you are still dedicating your time to creating something that can later be sold. Let’s say you are a motivational speaker. You will still have costs for things like notebooks for participants, meals, and facility rental costs. And let’s not forget your precious time!
All of these should be factored in when calculating your margins, even in a service related business.