Accountancy

Profit margins in times of inflation

At the beginning of the year, several suppliers announce price increases.  In addition, wage and other cost increases are possible. It is therefore essential to have insight into how these changes affect your business operations. This enables companies to take timely measures to protect their profit margins.

What is a profit margin?

A profit margin is a percentage that indicates how much of the turnover you have left as profit, after deducting all costs. It shows how many euros invoiced actually translate into profit.

There are different types of profit margins, but the two main ones we’ll focus on are gross profit margin and net profit margin.

  1. What is a gross profit margin and how do we calculate it?

    The gross profit margin is the percentage of turnover that remains after the cost of goods or services sold has been deducted. It gives a picture of how efficiently you sell your products or services.

    Gross Profit Margin = (Gross Profit / Revenue) x 100

    Example: annual turnover is 500,000 euros, compared to purchases of sold goods of 300,000 euros. Gross profit would then be 200,000 euros.

    Brutowinstmarge is (200.000 / 500.000) x 100 = 40%.
    In concrete terms, this means that for every euro earned, after deducting your direct costs, you have earned 0.40 euros in profit.

  2. What is a net profit margin and how do we calculate it?

    The net profit margin is the percentage of turnover that remains after all costs have been deducted, not only the direct costs of the goods sold but also operational costs, taxes, financial costs, etc. This percentage provides a more detailed picture, insight into the profitability of companies.

    Net Profit Margin = (Net Profit / Revenue) x 100

    Example: we start from the previous example, in addition to which there are also operational costs such as publicity, rent, wage costs for an amount of 75,000 euros. There are also taxes paid in the amount of 15,000 euros. Net profit = 200,000 – 75,000 – 15,000 = 110,000 euros.

    The net profit margin is (110.000 / 500.000) x 100 = 22%.

    In concrete terms, this means that for every euro earned, after deducting all costs, you have earned 0.22 euros in profit.

Why should we manage profit margins wisely?

Profit margins provide a picture of the health of a company. High profit margins can indicate a strong business model and good profitability. Healthy profit margins indicate that a company is managing its costs effectively, has more room for growth, innovation, investment.

Keeping an eye on profit margins is important for several reasons:

  • Insight into profitability: monitoring profit margins provides a clear picture of which products or services are actually profitable;
  • Strategic planning: gaining insight into your margins ensures better planning for the future, including decisions about expansion, investments and entering new markets;
  • Pricing strategy: by understanding margins, you can set prices that are both competitive and profitable;
  • Financial health: Healthy profit margins contribute to the financial stability of your business. They help build reserves for future investments and absorb economic fluctuations.

How do we manage our profit margins effectively in times of inflation?

There are several strategies that businesses can consider to increase or protect their profit margins:

  • Cost control: Analyze and optimize operational costs.  Examine your fixed and variable costs and see where you can save without sacrificing quality. Savings can be found in more efficient production processes, smarter procurement strategies, and reducing waste;
  • Inventory management: Overstock can significantly increase your costs. To avoid this, work with strict inventory planning;
  • Review pricing strategy: Analyze the impact of higher procurement costs and determine if a price increase is necessary. Increase sales prices if possible, without scaring off customers. Emphasize the quality, the value of your product and communicate what the price increase is necessary for;
  • Evaluate product portfolio: Focus on products or services with a higher profit margin. Consider removing less profitable products from your range;
  • Innovation and product development: develop new products or improve existing products to provide higher value and thus justify higher prices;
  • Diversification of suppliers: research alternative suppliers who may offer better conditions or prices;
  • Improved customer relationships: invest in customer satisfaction and loyalty;
  • Upselling and cross-selling: encourage customers to purchase additional products or services that are complementary to what they already purchase;

Conclusion:

Maintaining and increasing profit margins is an ongoing process.  Evaluate your strategy regularly and be prepared to make adjustments.  Maintaining healthy profit margins is essential for the success of your business, especially in challenging economic conditions.  By being proactive and making strategic choices, you can limit the impact of price and cost inflation and keep your business financially healthy. Do you need advice on optimizing your profit margins?  Feel free to contact us.  We are happy to help you!

Author
Natacha