Sales margin is an important calculation for any business owner because it is key to understanding the profitability of the goods or services you sell. Regularly calculating sales margin helps you understand whether or not an item is profitable, and also lets you compare profitability of that item over time. It should also be a number you reference in your pricing strategy.1
A sales margin calculation measures the amount of profit you make on the sale of a product or service after all costs related to the item are accounted for. The higher your sales margin, the higher your potential for profit on that product or service. Sales margin is also sometimes referred to as gross profit margin because it accounts for the materials and other costs that went into making your products. However, it’s important to note that sales margin calculations do not factor in operating costs of the entire business, such as facility costs or insurance, so it is not a measurement of the overall profitability of the business.1,2 The calculation for sales margin is simple: (Revenue – Cost of goods sold)/Revenue = Sales marginWhat is sales margin?
How to calculate sales margin
The common pitfall of calculating sales margin is failing to factor in all of the costs that go into making and selling the item when determining the “cost of goods sold” field. For example, you should include any sales discounts or allowances, the cost of the materials needed for the good or service, payment made to employees for producing the good or conducting the service, and any salesperson commission.3,4
Gross profit versus gross profit margin
Sales margin, also known as gross profit margin, is expressed as a percent. You may also see that you can calculate gross profit, which is expressed as a dollar amount. While both calculations show profitability, sales margin is a more useful comparison against competitors or the industry standard because it shows the relative profit between companies of different sizes, structures and operating costs.4
Sales margin formula example
Let’s say that you want to sell a service for $100 but aren’t sure if that will yield a good profit. You determine that the cost of the materials needed in the service is $10. And the cost of your time to complete the service is $40. You would calculate your sales margin as follows:
[100 – (40+10)] / 100 = Sales Margin
You would find that your sales margin is 50%.
Sales margin best practices
But what is a good sales margin? That can vary depending on industry standards, type of product or your own business goals. While there’s no universal benchmark for a good sales margin, there are a couple of great ways to leverage sales margin calculations when trying to determine the overall health of your business and product.
One way is to compare yourself against similar products or services in your industry. Ideally you should be on par with, or higher than, similar businesses.
A second way is to calculate sales margin at various intervals throughout the year. Then you can see how different internal and external forces affect your sales margin.5
Regardless of how you choose to use the information, knowing how to conduct a sales margin calculation is an important tool for any small business owner to have in their back pocket.
Sources
[1] https://smallbusiness.chron.com/sales-margin-18383.html
[2] https://www.investopedia.com/articles/personal-finance/093015/whats-good-profit-margin-new-business.asp
[3] https://www.accountingtools.com/articles/how-to-calculate-sales-margin.html
[4] https://www.masterclass.com/articles/gross-profit-vs-gross-margin#what-is-gross-margin
[5] https://quickbooks.intuit.com/in/resources/finance-and-accounting/what-is-gross-profit/
