9 Strategies for How To Improve Profit Margin (With Tips)
Updated November 29, 2022
Profit margins are essential when evaluating profitability. Gross, operating and net profit margins contribute to a company's financial statements and showcase efficiency with cash flow. Improving these profitability metrics can benefit a range of business processes that support growth and development.
In this article, we explore what a good profit margin is, how to improve your profit margin and why these metrics are important to monitor.
What is a good profit margin?
A good profit margin depends on several factors, including the type of business, profit goals, industry and profit margin. In many industries, an efficient profit margin falls between 5% and 20%, in which a 10% marginal rate is moderate and desirable for many businesses.
A 5% profit margin can show costs exceeding revenues, and a 20% profit margin shows a high marginal rate. While it's often more advantageous to have a higher profit margin, as this metric nears 20%, it can also show a company is generating more revenue than it can cover in expenses. Several profit margins also exist, each with its own calculation and importance to financial documentation:
Gross profit margin: The gross profit margin is the profit value of all sales subtracted from the cost of goods sold (COGS). For example, if a business generates $500,000 in sales revenue and has $190,000 in COGS, its gross profit is $310,000 with a gross profit margin of 62%.
Operating margin: The operating margin results from the operating profit, which is the amount you get from subtracting operational expenses and COGS from sales revenue. For instance, if you have a sales revenue of $30,000 and operational expenses and COGS of $11,500, the operating profit of $18,500 gives an operating margin of 61%.
Net profit margin: The net profit margin is what most professionals and is the net profit after subtracting all COGS, operational expenses and indirect expenses, like taxes and interest. For example, if revenue is $735,000 and net profit is $105,000, this gives you a net profit margin of 14%.
How to improve profit margin
Use the following steps to increase efficiency, customer satisfaction and productivity and improve overall profit margins:
1. Track efficiency
Operational efficiency is essential in acquiring, processing and completing customer orders and transactions. Improving operational efficiency is one approach to understanding how these processes affect the overall profit margin. For instance, increases in efficiency can come from automating customer orders, implementing tracking software for shipping data and monitoring the performance of production, sales and warehousing staff.
2. Develop sales strategies
Sales strategies for pricing, valuing and promoting products and services are also important methods for attracting customers and increasing revenue. Consider evaluating the resources that support sales and marketing activities and determine which strategies work to generate continuous revenue. It's also important to review the costs of current sales strategies to identify which methods need improvement.
3. Increase customer retention and lead conversion
Customer retention is also important for business profitability. Satisfaction and repeat transaction metrics can show how much of the profit margin accounts for repeat transactions like subscriptions, product updates or combined purchases. Understanding retention and satisfaction rates can also support strategy development to improve service, product quality and loyalty offerings. As customer retention increases, revenue can also enhance the overall profit margin.
Lead conversion is a marketing metric that can tell you how effective promotional strategies work to attract new customers. Increasing lead conversion, website traffic and overall brand awareness is essential to improving the probability of leads becoming customers. Consider analyzing your conversion strategies to determine which methods are most successful. Allocating resources to strategies that increase interest can create more sales, also leading to improvements in the profit margin.
4. Evaluate revenue streams
Profit margins are essential to understand how effectively businesses allocate resources to revenue generation. Therefore, it's important to measure various sources of revenue to determine which are costing the most for the least return. Eliminating inefficient income streams that use more funds than others can help you allocate more to these successful methods, further improving the profit margin.
5. Reduce costs
Maximizing efficiency also means reducing operational costs, such as utilities, company spending, commercial subscriptions and materials. For instance, a business might renew necessary subscription fees at lower costs, or a company might downgrade its unused technology applications. When improving profit margins, eliminating unnecessary expenses and reducing required costs are common factors businesses consider.
When you prepare to source your materials and other necessary production items, consider finding the most cost-effective methods of gaining those materials and products. You can negotiate lower prices for a longer contract with providers you already have. You can also search for less expensive locations from which you can get your materials to save on the cost of production.
Read more: 38 Cost-Saving Methods for Your Workplace
6. Invest in development
Sales and customer service teams with the expertise necessary to oversee customer accounts, support processes and overall sales practices can also benefit the profit margin. Investing in training and development that supports teams' abilities to manage customer service and sales activities bolsters improvements in customer satisfaction levels. As teams reach new sales and retention objectives, the profit margins can increase, too.
7. Eliminate low-performing goods
Many companies may also consider retiring outdated and low-performing products, as the continuous costs of unsellable goods can reduce the overall profitability. For instance, a company can evaluate its outdated products or services according to the industry's standards. Using this information, the company can either adjust and update the products or eliminate them. Both actions can mean more cash to allocate to the products, which increases sales revenue and profit margins.
Related: How To Calculate a Profit Margin
8. Inspire staff
Having a staff capable of effectively selling your products can improve an organization's profit margin. This includes having happy and comfortable staff within their roles and who know the best practices for selling merchandise. You can generate knowledgeable staff by training them effectively and encouraging them to use the products they sell so they have specific product knowledge.
9. Improve inventory management
One reason a profit margin may decrease is because of markdowns. Markdowns are a decrease in price because there's too much inventory of that product or a surplus. Managing the inventory can help you find the best balance between the number of products you store and the amount you sell, allowing you to improve a company's profit margin.
Why is profit margin important?
Each profit margin is important for evaluating a range of processes within a business. Consider several applications for which profit margin is important:
Evaluating cash efficiency: Profit margins are essential when evaluating cash flow efficiency. Businesses often use profit margins to understand the efficiency of reinvestments back into business activities.
Estimating financial health: The profit margin is also important for evaluating the overall financial position of a company. For instance, a company may analyze its profit margins to determine how its profitability affects its financial standing in its market.
Providing insight into productivity: The profit margin can also be an important indicator of business productivity. Operational processes, customer service and sales activities all support revenue generation, so tracking marginal rates can help improve productivity in these areas.
Supporting decision-making: Businesses also use profit margin values and other financial metrics to make important decisions. Budgeting, resource allocation and investment activities are several metrics you can analyze along with profit margins to make cost-saving decisions.
Benefits of improving profit margins
Improving the gross, operational and net profit margins is crucial for adding to business growth and financial health. Consider several more reasons why evaluating and improving profit margins is beneficial:
Adds to profitability: Improving the profit margin can add to the bottom line of a company's income statement, indicating its ability to invest in business growth and ongoing activities.
Supports investment activities: Improving lower profit margins can also benefit a business's ability to reinvest its revenues into growth and development, further adding to its total value.
Helps investors evaluate risk: Investors may often use the profit margin to get an idea of how risky a certain company is for investing in, and improvements to the profit margin can show investors a company has lower investment risk.
Explore more articles
- How To Earn Your Home Health Aide (HHA) Certification
- 5 Examples of Insubordination in the Workplace (With Tips)
- How To Add a Page on Microsoft Word Documents (With 3 Methods)
- 26 Fun and Easy Babysitting Ideas To Keep Kids Engaged
- 20 IT Industries (With Importance and Career Options)
- Wheel of Life: What It Is and How To Use It To Find Balance
- How To Zoom In and Out on a Computer (5 Methods)
- How To Accept or Decline an Internship Offer (With Examples)
- 5 Motivation Theories To Use in the Workplace (With Tips)
- 5 Types of Academic Degrees: Which Is Right for You?
- Market Segmentation and Targeting: Definitions and Examples
- Expository Writing: Types and How To Write in This Style