In control financial of a company, many are the indicators to be calculated and considered in the analysis for decision making. After all, making use of them is a quick and safe way to make assertive decisions, based on real data about the company's situation.
THE profit margin, in turn, is one of these indicators and can be considered one of the main ones to understand the profitability and profitability performance of the business, it is essential to know the difference between gross, net and contribution margins.
To understand whether the company's financial return is being as expected, not only by the partners, but also in relation to competition, it's very important. In addition to indicating the success or failure of the operation, the profit margin is very important in determining the company's market positioning and what your next steps will be.
In this article, therefore, we will approach the topic from the following definitions:
- what is profit margin;
- difference between profit and profit margin;
- difference between gross, net and contribution margin;
- keep an eye on what the numbers tell you.
If you want to learn the difference between them and also how to calculate them correctly, continue with us!
What is profit margin
The profit margin is defined by the percentage of the company's revenue that remains after subtracting costs, taxes, interest, depreciation and all other expenses generated by its production and marketing.
That's why, selling a lot does not necessarily mean making a profit. In some cases the company's commercialization is large, but its production is so expensive that it does not provide a good profit margin.
In this scenario, this difference in profitability is the indicator that can most prove this statement. Because selling a lot, but having little return, at the end of the day, is a big problem.
A good example of this is the comparison between the profit margin of a luxury article with the profit margin of a simple article of consumer good.
The luxury item is sold in smaller quantities, but for a significantly higher price. Therefore, this product is produced on a smaller scale, demands less labor costs and storage space, guaranteeing a larger profit margin.
In the case of a simple consumer item, high production brings more labor costs and storage space.
And there is also greater need to offer a competitive price to the market, because generally the number of competitors producing similar goods is much higher.
Consequently, the profit margin, that is, the value earned on each item sold, is much smaller.
Why is it necessary to know the company's profit margin?
As we mentioned earlier, the differences between selling a lot and making a big profit are very big. If you deceive yourself with the magnitude of the first, it can result in a significant loss of the company's capital, due to the lack of measures to increase the turnover and production values.
After all, when there is little effective return, the company starts to have limitations not only to grow, but also to compete in the market.
That's because, in the end, the profit margin is included directly in the final price to be charged for product or service offered by the company.
If this value is not very well structured, it will not bring significant financial results. Besides, most likely, it is not very attractive to the market.
Therefore, it is necessary to understand and control the overall cost very well, that is, what each of the values subtracted from the revenue to obtain the profit margin. And the gross margin, net margin and contribution margin calculations clearly present this information.
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Difference between profit and profit margin
Before we go into the details of the definitions and the difference between gross, net and contribution margin, it is essential know the distinctions between profit and profit margin.
The profit of a company is nothing more than any positive return from an investment. In other words, profit is the income obtained from the sales of products or services – which at a certain moment demanded investments to be produced.
The profit margin, on the other hand, is the percentage that the company has on top of its sales. Thus, each product or service offered by a company, has its own profit margin.
In other words, the profit margin defines the percentage value that will be added when pricing a product or service so that its production and commercialization is really worthwhile to bring gains to the company.
In this sense, the profit margin represents not all of the company's gain but the difference in values that she had between all her expenses and the final price she received.
In other words, the profit margin is the amount that the company has “surplus” and that is not committed to accounts or other operating expenses.
The gross margin is calculated from the gross profit. IT'S the percentage that indicates how much the company sells after subtracting all costs involved in the production and marketing of the product or service offered.
It is a very important indicator, because it defines the percentage that measures the profitability and return on investment of the business.
Its importance is because this percentage becomes the indicative factor for the need to change prices, revise the portfolio, change suppliers, the need for more or less raw materials and labor, among others.
When the gross margin is below expectations, it is a sign that the company needs to look for new ways to save on production or increase the final cost of the product. Çotherwise, in the coming months the organization will move towards a negative balance.
The calculation of gross margin
The gross margin calculation is done as follows:
Gross Margin = Revenue – Deductions – Direct Variable Costs x 100
To make it clearer, revenue is the entire amount sold, deductions are the amounts of taxes, interest and depreciation and variable direct costs are the amounts spent on raw materials and labor necessary for the production and commercialization of the product or service.
Important: administrative costs should not be considered in this calculation.
Here it is interesting to understand that variable direct costs have this definition precisely because they vary according to the performance of sales. In other words, expenses with more or less raw materials and labor vary according to the production required to supply the market.
The net margin, then, is calculated from net income. In this sense, it ends up being a little more complex than the gross margin. Let's understand why:
The net margin determines the company's real gain, as it subtracts from revenue absolutely all costs, not just those of production and marketing.
In other words, it also subtracts administrative costs, defaults, depreciation of equipment, rents, insurance, among others.
In other words, the net margin is the final profit amount that the company receives for each product sold. It is through it that one can keep in mind the most real value of all, which should be used for calculation when increasing or decreasing the price of a certain item.
The calculation of the net margin
The calculation of the net margin is done as follows:
Net Margin = Revenue – Deductions – Direct Variable Costs – Indirect Costs x 100
In the calculation of the gross margin, we already had the definition of revenue, deductions and variable direct costs. You indirect costs, in turn, are defined by the expenses listed above: administrative costs, defaults, depreciation of equipment, rents, insurance, between others.
The contribution margin is the revenue that remains after subtracting all variable expenses. These, in turn, are the sum of variable costs and variable expenses.
At the end, it is defined how much the profit from the sale of each product or service will contribute for the company to cover all its costs and expenses and still generate more revenue.
That is, based on the calculation of the contribution margin, it is possible to calculate the minimum quantity of products that the company needs to sell in order to profit.
Keeping it in mind is essential for companies that are expanding, as it will indicate a path to be worked on in relation to values.
It is based on this calculation that the company will be able to outline its plans for the coming months, as well as creating projects to continue on a growth path.
Calculation of contribution margin
The calculation of the net margin is done as follows:
Contribution Margin = sales revenue – expenses (variable costs + variable expenses)
The definition that we do not yet have to carry out this calculation is that of variable expenses. Variable expenses are those that vary in proportion to the volume produced / sold. This way, there will only be the expense, if there is the sale or the production. A good example of variable expenditure is the commission.
Before carrying out the calculation of the contribution margin, therefore, it is important to clearly separate everything that is fixed and variable cost, as well as everything that is fixed and variable expenditure.
Keep an eye on what the indicators tell you
From the descriptions of profit, profit margin and their types, it is now possible to have a broader view in relation to the company's earnings and especially the importance of correct pricing of each product or service offered.
This closer look at the metrics makes all the difference and ensures more focus and strategy in the company's financial management.
However, it is essential to remember that the financial management of a business must take into account a set of indicators that relate to each other and that enable the delivery of specific analyzes.
And, going further, the big secrets of success are not just about guaranteeing high numbers in the profit margins of absolutely all products or services offered by your company. There are several strategies on the market that aim to obtain revenue in alternative ways. Check out one of them below!
The bait format is a sales strategy widely applied in the market: the use of “bait” products or services to attract consumers and make them buy more. Often these “baits” are close to zero profit margins, but they guarantee the attraction and loyalty of a huge number of customers.
And it ends up being worth it, because the profit margin that is not applied to the “bait”, is very well applied to the other products or services that consumers are induced to buy under the influence of the “bait”.
In addition, the minimum profit percentage for each product, as established in a mass sale, ends up becoming a satisfactory number for the company. As such, it will profit not by large amounts on a few sales, but by a small margin on infinite sales.
Importance of indicators
So the biggest tip here is to always keep an eye on what the indicators tell you, even when they indicate zero. From then on, it becomes possible create mega assertive sales strategies and make the best decisions for the development of the company.
Furthermore, it is important to never forget that, even if profit is important for the growth of the company, it cannot be the flagship of its operation. It is necessary to build a culture with a focus on productivity, which will bring much better results in the long run.
So, was this article useful for you? Did you like to know the differences between gross, net and contribution margins? So, be sure to comment on your perceptions and doubts to continue with the discussion of the topic!
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