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Let’s have a look at exactly what a “margin” is. The Wiki says:
“Profit margin, net margin, net profit margin or net profit ratio all refer to a measure of profitability. It is calculated by finding the net profit as a percentage of the revenue.”
The profit margin is mostly used for internal comparison. It is difficult to accurately compare the net profit ratio for different entities. Individual businesses' operating and financing arrangements vary so much that different entities are bound to have different levels of expenditure, so that comparison of one with another can have little meaning.
A low profit margin indicates a low margin of safety: higher risk that a decline in sales will erase profits and result in a net loss.
Profit margin is an indicator of a company's pricing strategies and how well it controls costs. Differences in competitive strategy and product mix cause the profit margin to vary among different companies.
The easiest way for me to remember it, is that the margin is the difference (financially) between what everything cost (not only materials, but also time and expenses [for me as a service type business] and research, printing, paper, ink, etc) and what I charge.
If your margins are too low, you will never make a profit and on the other hand if you set your margins too high, you run the risk of never making a sale – it’s a delicately balanced scenario!
Essentially there are two ways to increase your margins, and those are either to cut costs or cut prices. In order to know which one to do, it is obviously essential that you focus on your margins on a regular basis and also on what the current economic trends are as it is not always a good thing to cut prices, although it is always a good thing to cut costs, as long as that does not interfere with the quality.
Upping your prices
Sometimes increasing the price of your services and/or your product has a powerful statement attached to it – it says “I’m worth it” or “the product is worth it”. I know that when I started out, I had nothing to compare my services to and the result is that I used my corporate ‘salary’ as a gauge to set my hourly rates – wow, was that ever a big mistake.
I priced myself far too low and the result is that I attracted many clients, all of whom desperately needed my expertise, but all of whom could not afford me! Within 24 months I had doubled my hourly rate and I was attracting clients who needed me, but who could also afford me.
In this particular instance, raising my charges had an incredibly powerful effect – it said ‘this is what I am worth’ and the psychological effect on me, as an individual, was incredible. Before, even though my prices were very low, I was chasing business by giving discounts, hoping to retain the very clients that could not afford my services in the first place – that was a very costly mistake – I wrote off a lot of money to bad debt.
Nowadays, if I am going to give a discount – it is because there is a huge value to me and it is based on a whole different set of criteria, such as (but not limited to) early or timeous payment etc.
Cutting costs is definitely the best way to increase your margins and thereby increase your profits. This is not always an easy thing to do particularly in tough times, when you are looking at staff and salaries. You have to divorce yourself from the emotions and look at the cold hard facts.
Can you do without this particular function being performed by a single person, in other words “Don’t make it about a person or personal”, but rather about what’s good for the company. If you have two people doing work that can be done by one person, then it stands to reason that you only need to employ one person – don’t get sucked into the emotional side of things.
Keeping your costs to a minimum and your clients to a maximum is therefore the best way to ensure that your margin remain on track and is the best way to meet and even surpass your budget requirements.