As a business owner, it is utterly mandatory to turn to mathematics and formulas in order to track your financial operations. Categorically, there’s no way in which you can assess whether your business is successful or not without being fully aware of the relationship between the investments made and the revenue generated. This brings us to another important metric – namely the average profit margin ratio.
The name already points what this metric is about. Namely, it calculates the average profit generated from the sale of a given service, service category or product.
If you’re one of the many companies that sell a wide selection of services or products, this KPI will turn out to be quite useful. That’s because each service/product usually generates distinct profit margins. It pays off to determine what is most efficient of them, to know what to focus on in the foreseeable future.
Concurrently, this becomes primordial in the case of firms featuring dynamic pricing models. At the same time,
if you embrace a flexible approach in regard to pricing, in order to accommodate your customers’ needs and specifications, this KPI might be a valuable tool for you.
There is another way in which you can use this metric, though. For instance, you can compare and contrast distinct profit margins generated by distinct services and products, or generated by sales representatives, or in given locations. As you can see, you can customize the metric depending on what you want to find out.
Essentially, each business’ goal, regardless of the industry in which it functions is to optimize its resources and generate profit. More specifically, each company wants to accomplish its highest potential in terms of profitability. This is what makes calculating the profit margin so important, as it clearly mirrors where you’re standing.
If a business focuses exclusively on having a high gross profit margin, this might result in an unrealistic pricing of the item or service. When the product or service is priced too high, generating profit might be even more challenging; so, it’s sensible to analyze the ins and outs of this approach beforehand. On the other hand, though, a profit margin that is too low will imminently result in a decrease of net profits, thus, restricting your capability of making investments or acquiring equipment, so on and so forth.
In this respect, after establishing the average profit margin for each service/product, if the result isn’t the one you were looking for, you might attempt to increase the net profit margin. Still, you should choose methods that won’t automatically make the price too high, as this will make your product unattainable.
Evidently, this will depend on your target audience, as well – meaning that for some businesses it might work, but that’s not a general rule that applies in all case scenarios. Usually, the gross profit margins out to remain steady. If, however, you notice that they are decreasing, the necessary adjustments should be made in order to ensure that the business remains profitable.