If you ask finance leaders how they can see success in the upcoming year, you’re bound to hear someone say, “increase profits.” Pursuing increased profits is a common goal, but there are other paths to fiduciary success, like aiming to improve profit margins instead.
Getting out of the profit mindset and into the mindset of improving net profit margins can take time, but with the right information, it’s possible for organizations and finance leaders to make the shift with relative ease.
What is the “net margin?”
The net margin is a metric by which the profitability of an organization is measured by dividing its net profit by total sales. It’s easy to confuse the idea of increasing profits with the idea of increasing the profit margin, but the two concepts are different and should be regarded as such.
Net margins can be increased by taking actions such as boosting sales or prices, which directly align with profitability. However, there are other ways to increase the net profit margin, such as taking measures toward reducing costs. This is as simple as cutting employee hours to as complex as sourcing different, cheaper raw material for your products.
Strategies for improving net margins
There are two major options out there for increasing profit margin: Increase revenue and decrease costs. We’ll provide an overview of each of these in this section.
Increasing revenue is one of the most common and popular ways to increase your profit margin. This directly aligns with increasing profits, as the way to most easily increase revenue is to raise the price of products or to find ways to sell more of them. However, it can be tricky to make sure that you’re not pushing your customers away or creating a supply-and-demand issue when you raise prices or sell more units.
There is a downfall to increasing revenue to boost the net profit margin: The net margin formula (Net margin equals net income divided by revenue, multiplied by 100) puts revenue as the divisor. Don’t break out your math textbook just yet—essentially that means that the greater the total revenue, the more it can impact your net margin and make your business appear less profitable than it actually is.
As any finance leader could tell you, operating a business is expensive. There are a lot of factors at play when it comes to operating expenses, but reducing costs is one of the most popular ways to improve an organization’s net margin.
Reducing costs generally involves relocating the business to a cheaper area, reducing the workforce or workforce hours, or leasing out unused space. However, it’s important to consider that these options are not right (or even feasible) for every organization and undertaking one of these moves to reduce operating expenses could backfire if your business isn’t ready.
There is another move an organization can take to reduce costs—though it may at first seem counterintuitive. “Scaling up,” or expansion, can allow businesses to reduce costs while maintaining the integrity of their products and their company. With increased production comes a decrease in the costs of areas like advertising, research and development, and administration, to name a few. This works because it effectively reduces the cost per item produced and drives higher sales profits—a great strategy for improving your long-term net margins.
Metrics for improving profit margins
The path to higher profit margins is paved with metrics. For you to know how to effectively improve profit margins, you must be familiar with each number associated with your business. From the cost of a paper clip to the salary of your IT administrator, keeping track of what costs you incur on a regular (and irregular) basis will give you insights into your business’s profitability and allow you to keep track of expenses in a more holistic way.
Managing metrics can be a monumental job, but it doesn’t have to be that way. With the right enterprise performance management (EPM) solution, you can stay on top of your metrics with streamlined dashboards and a plethora of tools for accurate and timely reporting.
There’s a lot of talk out there about increasing profits, but there’s more to a successful financial quarter or year than profits. More and more businesses are shifting to a mindset of profit margins over strict profitability, and for good reason.
Taking steps to reduce costs and increase revenue will make a marked difference when it comes to improving profit margins and making the most of margins requires a firm and thorough understanding of all the metrics your business uses.