Enough about t-shirts … Let’s talk about some business basics!
When you are a small business, increasing revenue is always at the forefront of your mind. It can be by increasing sales or decreasing expenses, companies are always looking out for the next big cost saving measure that will increase cash flow. However, one figure that is essential to raising the bottom line, a company’s Profit Margin, is actually rarely ever calculated by small businesses. A business’ profit margin is the easiest and quickest way to calculate how efficiently a company is spending and how profitable it is becoming.
Let’s start by defining Profit Margin. Profit margin is basically the ratio of profits earned compared to the total costs over a defined period (quarter, year, etc). Generally, each industry will have an average profit margin due to associated costs and materials needed for different products.
There are two types of profit margins that small businesses may find useful: Gross Profit Margin and Net Profit Margin.
Gross Profit Margin is used to determine the profit margin of a single, particular item or service, not the business as a whole. To determine this figure, a business looks at the retail price of a product and then subtracts the costs used to produce it (materials/labor). You then divide that figure by the retail price to calculate the gross profit margin of that product.
Net Profit Margin is the equation used to determine an entire company’s profit margin. To calculate the net profit margin, you take the company’s total sales for a given period, subtract total expenses, and then divide that figure by the total revenue.
For example, let’s say your company generates $1000 in t shirt sales with an operating expense of $500. The net profit margin would be 50%.
Examining your net profit margin is a great way to look for ways to boost your revenue, or to take an inventory of what you are spending versus what you are making. It is a tool that will help you isolate what products are affecting your total sales and whether or not to continue to offer that product. It can also help analyze why you have seen a decline in total revenue by identifying increases in spending costs or decreases in sales.
The only catch to conducting a profit margin analysis is that it takes times and effort to gather and verify all costs. To get an accurate net profit margin, a company must include every expense as part of the total. This includes things like utilities, inventory, administrative costs, shipping, etc. Every line item in your ledger that accounts for money being paid to someone else must factor into your total expenses line item.
Similarly, all revenue must be counted as well. Don’t forget non-traditional revenue sources, such as transaction fees or maintenance contracts. Chances are that you will have a much clearer picture of your revenue stream than you do your expenses, so be careful to avoid miscalculations.
Now that you’ve calculated your net profit margin and analyzed it, you can make decisions on how to move your tshirt company towards greater revenue. If your net profit margin is outstanding, there’s no immediate need to make any changes.
If your profit margin is good, this could be the perfect time to explore growth opportunities and possibly taking a look at increasing sales to see how that might affect future profit margins. And if your profit margin leaves something to be desired, it’s probably time to make a change and examine ways to make a profit by decreasing expenses.
In all instances, it’s a good idea to take a long look at any changes that might result from tweaking your profit margin. Always consider your customers, employees and brand when making any kind of change.
Net profit margins are great tools to analyze your t-shirt business and are also a great benchmark to look at each year. It’s a better measure of a company’s profitability since it takes expenses into account and not only sales.
Profit margins are simple and effective ways to check in on the finances in your company. Small business owners can boost their bottom line by keep tracking of these figures!
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