Sales margin calculation: An essential profitability metric

Margin calculation is an important step in analyzing a company’s profitability. This financial indicator is one of the important accounting KPIs used to assess the financial health of a company.

The calculation of the margin rate is a tool that is often used in order to know the exact amount of profit on each sale made by a company. A distinction is made between the calculation of the gross commercial margin, that of the net margin, the margin rate, and the mark-up rate. In this article, discover all the essential elements for calculating the margin: the different financial indicators as well as the methods for calculating the margin. 30+ Top Products to Buy Cheap and Sell High

Margin rate calculation: presentation and explanations

The margin rate most often refers to the gross trading margin. This is the percentage of margin made on a product, that is to say, the difference between the price at which the company buys a product, and the selling price of a product. The calculation and monitoring of the margin rate aim above all to measure the profitability of a product compared to the competition within the same sector of activity.

In concrete terms, the margin rate, therefore, designates the difference between the cost price of a product and its selling price.

Margin and Margin Rate Calculation Method

To calculate the commercial margin rate, it is first necessary to define the cost price of a product. To do this, we generally add up all the expenses necessary for the manufacture of a product or the marketing of service without adding incidental expenses and general expenses (labor, marketing expenses, etc.).

The entrepreneur can then define his margin in value and in percentage. To start, it determines the margin in value according to the following calculation.

Commercial margin calculation:

  • Gross commercial margin = Selling price excluding tax – Purchase cost excluding tax.

Then, the formula for calculating the net sales margin excluding tax must be applied:

  • Margin rate = (Gross commercial margin / Purchases excluding tax) * 100.

For example: let’s imagine an activity of buying and reselling soaps. An entrepreneur buys soaps for 2 euros each excluding tax and resells them for 3 euros each excluding tax.

Thus, its commercial margin is:

  • Commercial margin = €3 – €2 = €1.

And the company’s margin rate is:

  • Margin rate = (€1 / €2) *100 = 50%.

For each sale of soap, the entrepreneur makes a margin of 50% or €1 per unit of soap.

Calculation differences between margin rate and markup rate

Although the terms markup and markup are very similar, they are actually used to calculate two very distinct elements.

While the markup rate assesses the relationship between margin and selling price, the markup rate assesses the relationship between margin and purchase price.

The calculation method is also different. The markup rate is calculated according to the following formula:

  • Markup rate = (Gross margin in amount / Turnover excluding tax) * 100

Difference Between Gross Margin and Net Margin

When calculating the gross margin, the purchase price excluding tax is subtracted from the sale price, as in the calculation above. But for the net margin calculation, it is also important to subtract the incidental and overhead costs that are necessary to complete the sale.

This metric is usually calculated by comparing the company’s net income statement to its revenue during an accounting period. A company’s net margin is therefore used to calculate its real profitability once all ancillary and ancillary costs have been taken into account. 15 Richest Countries In The World

To summarize, the gross margin is an indicator that aims to assess the profitability of an activity or a product compared to the competition. But the net margin is the real indicator of a company’s health and is used to know if the company is really profitable.

Thanks to the net margin, the vision is, therefore, more global and closer to the real financial situation of the company.

Let’s take a concrete example. We have seen that our entrepreneur whose activity is the purchase and resale of soaps achieved a gross sales margin of 50%, or €1 margin on each sale of soap.

To calculate its net margin, we will also take into account elements such as the salary of the salesman of his soap shop, the rental costs of the shop, the price of the personalized packaging of the soaps, etc. all smoothed over an accounting year.

As you can see, taking all of these things into account, the net margin of the soap business will be much lower than the gross margin. How to Start a Handmade Soap Business

Both metrics are important. If a company’s gross margin is lower than that of the competition, it may mean that its selling price is too low, or that the negotiation with the soap supplier can be further optimized. If the gross margin is correct but the net margin is too low, this may mean that the company is making too many ancillary expenses: shopping too expensive, labor costs too high, etc.

How can a company increase its margin rate?

If a company is not profitable according to the calculation of the margin rate, several solutions are possible. The first is to increase its margin rate; either by increasing the selling price or by lowering the cost price of a product or service.

For example, in the case of the soap business, the entrepreneur can choose to find a cheaper supplier of soaps, or sell his soaps at a higher price.

If the gross margin rate is suitable compared to other companies in this sector of activity, the entrepreneur may consider other levers for reducing costs, such as renting a less expensive shop, lowering packaging costs, or even marketing and communication costs. How To Calculate Selling Price For Your Products: How to Price Your Products

There is no global approach that can correspond to all companies. Once the margin has been calculated, the entrepreneur must analyze the cost items in detail and act with caution to mitigate the various levers without having a significant impact on his current activity.

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In summary

The calculation of a company’s margin is an essential financial indicator to assess the positioning of the company in relation to the competition (gross commercial margin), but also the ratio between the net result of the company and its turnover. . With these elements, the entrepreneur can then make various management decisions to increase his margin or lower ancillary expenses and general expenses in order to increase the net margin. Four easy home business ideas for women!

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