Revenue vs. Margin: Why Profit Margins Matter

Financial Goals: Target Revenue or Profit?

As with any other company, businesses often look forward to increasing revenue. A 2015 study conducted by SME lender Fleximize shows that 49% of the companies surveyed are optimistic that their monthly revenue will increase in the following year.

This shows that business revenue is often used as a basis for entrepreneurial success and profitability. However, this belief is something that should be reconsidered as profit margins may play a bigger role than you think.

Why profit margin matters

Fundera perfectly describes what profit margins are—this is the percentage that shows how much of your revenue is actual profit, or money earned, as opposed to business costs and expenses. Overall, profit margins are often used to gauge a company’s financial health.

According to Vend’s 2018 research, the average gross profit margin in retail is 53%. The report illustrates that even though beer, wine, and liquor stores raked in the highest revenues, their margins were the lowest with an average of around 35.64%. On the other hand, beverage manufacturers only brought in an average of $26,159 monthly revenue but their profit margins were the highest out of all other industries at 65.74%. This signifies that most companies in the beverage manufacturing industry were able to achieve a good balance between gross revenues and margins.

To put everything into perspective, a high annual income may also mean that you are spending more on monthly operational expenses in order to boost your business further. This can lead to a low-profit margin, which means that your company may only break-even when it comes to sales. Since margins are tight, this ultimately gives you less flexibility in case you plan to expand in the future.

Profit margins may also play a key role in identifying issues that need to be resolved. To cite an example, a low margin despite having a team working round-the-clock may indicate that there might be a problem in your pricing structure or expense management. Despite staff productivity, the company is not earning enough revenue because they priced their services too low.

Achieving higher margins 

From this alone, one can infer that cutting down on expenses is the solution to gaining higher profit margins and improved company flexibility. However, Investopedia also highlights the fact that decreasing costs does not mean better profit margins. In most cases, this can even lead to lower revenue.

This raises the question: How can you increase profit margins instead of simply relying on boosting revenue?

Putting all your energy on marketing and selling higher-end products can help. Business motivational speaker Tony Robbins encourages entrepreneurs to market products that bring in the most income and help increase your profit margin percentage, especially since quality products inspire brand loyalty.

Keeping a close eye on product inventory is also a must. There was a time when retailers suffered a globally accumulated total loss of $1.1 trillion due to overstocks and out-of-stocks. When an item is simply sitting in your warehouse, your business cannot add it to your monthly profit margin. Overstock can also lead to markdown sales—which can lower your profit for the sake of selling the item. Similarly, repeated out-of-stock items can affect customer loyalty. Order fulfillment takes longer and there are fewer opportunities for impulse purchases. 

Finally, reducing costs is a faster way to further boost margins. The less your monthly expenses are, the more you offer your company the opportunity to expand in the future. This may mean relocating your company to an office with lower monthly rent or something as simple as investing in one project management tool that fulfills two features rather than two programs for separate needs.

In conclusion

Oftentimes, business owners prioritize increasing revenues as it is believed that the higher the income, the more successful a company is. However, your profit margins can give you an overview of how efficient your company is, which makes it crucial to consider when planning your business strategy. Ensure that you consider maintaining good profit margins that will protect your cash flow, and make the business grow. 

 

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