Sales margins are a key metric for businesses in the Philippines.
Whatever your business is selling, a product or a service, it’s critical to understand what profit (or loss…!) you are making on each product sold or service offered.
If your business has engaged a competent accountant in the Philippines, they should be able to consistently provide you with up-to-date and accurate financial information and reports that you can rely on to understand and improve your sales margins.
To help you really understand the implications that your sales margins can have for your business, we have outlined in this article:
- Why sales margins are so important;
- How to compute your sales margin; and
- How to increase your sales margin!
But first, what is a sales margin?
What is a Sales Margin?
Sales margin is a performance measure that identifies the amount of profit or loss generated from a product, product line or service over a period of time.
By monitoring your sales margins, a company can identify the profit value for each product, product line or service and make informed commercial decisions based on this information. Your sales margin will also be relevant when analysing your company’s cash flow.
It will also help you to understand the effectiveness and efficiency of your business operations. For example, higher sales margins may indicate effective cost management. Lower sales margins might highlight a need to re-budget, rethink your sales strategy or dispose of underperforming products or services!
How to compute the Sales Margin
Sales margin for a product or service is computed as total revenue less the cost of sales, including any costs directly attributable to the sale. To express sales margin as a percentage, simply divide the sales margin figure by the total revenue figure.
Here’s how it would look:
|–||Less Cost of Sales|
|–||Less Selling Costs directly attributable to sales|
“Cost of Sales” generally includes all expenses or costs that relate directly to bringing the product or service to the market. For example, labor, raw materials, etc. “Selling costs directly attributable to sales” are expenses related to commencing, processing or completing a sales transaction and might include sales commission, customer discounts, etc.
How about an example!
We often find that a real-life example is the best way to explain accounting concepts! Let’s use an electronics retailer in this example.
Let’s say the retailer sells freezer units to the total sales value of $125,000 during a particular month. The retailer granted sales discounts to the value of 10% of the selling price. The Cost of Sales was $65,000. Commission paid by the retailer on the sales was 2%. The retailer also includes an installation service with each sale. Total installation service costs for the month amounted to $2,500.
The result? The Sales margin is $42,500. This is computed as: $125,000 – ($125,000 x 10%) – $65,000 = $47,500. Deducting further the selling costs equal to $5,000 (computed as $125,000 x 2%, + $2,500 for installation services). Arriving at $42,500.
Expressed as a percentage? Simple. Divide Revenue ($125,000) by the Sales Margin figure ($42,500). This gives us a sales margin of 34%.
What’s the benefit of understanding your Sales Margin?
It’s not enough to just know your sales margin! The real value comes from using this information to find a way to generate more profits when selling your goods or services. Through consistent and accurate financial reporting, a company will be in a much better position to rely on the information it generates!
Here are some common ways in which companies can use knowledge of their sales margins for commercial benefit:
- Budgets and forecasts
The sales margin computation is a tool used by management to understand a company’s financial data and assist with management decisions. Sales margins can be very helpful when developing budgets and forecasts. If you know how much profit each product or service is making for your business, it is much easier to plan for inventory, labor requirements, marketing campaigns, etc.
Remember though – the sales margin computation does not include other costs that are not attributable to sales. So while your sales margins are undoubtedly helpful to understand profitability on the sale of goods and services, the sales margin should not be used as the indicator of the overall profitability of the business!
- Measure of product profitability
A primary objective of a business is usually to generate income. For many businesses, the main source of income is through the products or services that they sell. As such, these businesses should always be aiming to ensure that their sales activities yield the highest level of profits possible. Understanding the sales margin as a measure of profitability per product or service can help companies determine product pricing, cost reduction strategies, scope for marketing activities and benchmarking against the competition and market.
- Product to product comparisons
An analysis of the sales margins should be performed consistently over a period of time. This can enable comparisons on a product to product basis. There is no point comparing sales margins for one product over the Christmas season against margins of another product during the summer. A company can then determine which product delivers the most profit and which product has the least potential to make money for the business.
- Analysis of Profit Levels over time
Proper use of the sales margin computation enables a company to analyse the level of profitability across a number of different time periods for a particular product. Sales can then be viewed by taking into account seasonal implications.
It would helpful to review sales margins over a monthly, quarterly, bi-yearly and yearly basis. This will give a true indication of the sales value of a product or services over a financial year. This can also assist the company when developing projects, forecasts and budgets for similar periods during the following cycle.
How to increase your sales margin
Increasing the sales margins should be an ongoing objective for a business. While it’s not easy, it can be achieved by using financial data to develop and tweak your pricing strategy. It is important that you have someone (e.g. a CFO) monitoring and advising on this financial data!
Outlined below are a few approaches that businesses might use to help increase their sales margins:
- Increase the sales price
Remember that the sales margin is the difference between total revenue and costs directly attributable to the goods or services. While increasing the sales price will increase the level of revenue (provided unit sales do not decrease), businesses must consider various factors that can make it difficult for a company to increase its selling price. These include competition, market powers, existing customer expectations, trade regulations, demand and supply. It might not make sense to increase the sales price if unit sales are going to decrease significantly!
- Increase the volume of sales
An alternative to raising sales prices is to increase the volume of sales. i.e. keep the existing sales price per unit but increase the number of units sold. Easier said than done, right?
Increasing the volume of sales may require new marketing campaigns, higher incentives for sales personnel, advertising, higher inventory costs, increased transport costs, etc. What does this mean? A likely increase in costs!
So before attempting to increase the volume of sales, remember that costs levels are also likely to rise! When contemplating such an approach, always be sure to consider the implications that this might have on your sales margin!
- Reducing costs
A popular, effective but difficult method of achieving a higher sales margin is by reducing the cost of sales and selling expenses. How can this be done?
Robust planning, forecasting and budgeting is crucial to low-cost and high-profit business operations. Manufacturing goods instead of buying finished products from suppliers may reduce costs. Using your own warehouse instead of paying high rents on third party storage may generate a cost-saving over longer periods of time. Replacing customer discounts with longer credit terms may reduce costs attributable to sales. Commission schemes might be tweaked to increase % commission at higher sales volumes.
There are a variety of ways to reduce costs, however, no at all will be available to every business! Further, the business must make sure that it does not let the quality of the goods or service suffer!
CloudCfo can help with your Sales Margins
To compute your sales margins correctly, you first need to have accurate and up-to-date financial information to work with. By engaging CloudCfo as your outsourced accountant in the Philippines, you can be confident in the financial data that you receive.
CloudCfo provides value added financial reports, including up to date P&Ls, trial balances and balance sheets whenever you need them! We don’t just send you the numbers. We highlight key ratios, identify KPIs and provide real financial insight to help you increase your sales margins and optimize the overall running of your business.