Do you want to increase the overall profitability of your agency or business? It is essential to understand and master the calculation of the margin rate. Like Return on Investment (ROI), the margin rate is a key indicator of your company’s profitability and financial health. Knowing how to calculate and analyze it can help you make informed strategic decisions, optimize pricing, and improve profit margins. Are you ready to uncover the concepts of profitability? Follow the guide!
Margin rate definition
What is the Margin Rate?
The margin rate represents the percentage of profit made on each euro spent to produce a good or service. It is calculated by dividing the margin (the difference between the purchase cost and the selling price) by the purchase cost, then multiplying by 100 to obtain a percentage.
The term commercial margin is used for commercial activities (buying and reselling), while the term gross margin or industrial margin is used for production or service activities.
What is the purpose of the margin rate?
The margin calculation is a key financial indicator for any business, and for good reason: it indicates the profit made on each sale. For entrepreneurs, margin is a key element of financial forecasts.
Depending on the industry, companies use the margin rate to…
- Evaluate the company’s sales performance;
- Position themselves against competitors in the same industry;
- Identify the evolution of the company’s strategy, whether it is declining or improving;
- Guide development decisions towards the most profitable products;
- Calculate the company’s break-even point.
Understanding and optimizing this rate are therefore crucial for a company’s strategic development and financial viability.
What is the difference between Margin Rate and Markup Rate?
The markup rate and the margin rate are often mistakenly confused. It is important to understand the difference to avoid any confusion:
- Margin Rate: This is the ratio between the gross margin (difference between the selling price and the purchase cost) and the purchase cost. This rate indicates how much the company earns per euro invested in purchasing its products.
- Markup Rate: It is calculated by dividing the commercial margin by the selling price excluding tax. It indicates the percentage that the margin represents relative to the final selling price offered to the consumer.
In other words, the markup rate is used to set the selling price based on the desired margin, while the margin rate is used to calculate the margin relative to the price of your product or service.
Margin calculation
How is the Margin Rate Calculated?
The calculation formula for the margin rate is as follows:
Margin Rate (%) = (Gross Margin) / Purchase Cost × 100
where the gross margin is the difference between the selling price and the purchase cost.
Practical Examples of Margin Rate Calculation
Example 1:
Suppose a product is sold for 20 euros and bought for 15 euros. The gross margin would be 5 euros.
Margin Rate = (5) / 15 × 100 = 33.33%.
Example 2:
For a service sold for 100 euros with a production cost of 70 euros, the gross margin is 30 euros.
Margin Rate = (30) / 70 × 100 = 42.86%.
These examples illustrate how the margin rate can vary depending on the purchase cost and the selling price, which directly influences pricing strategy and product selection.
Margin rate types
What is the difference between Gross Margin and Net Margin?
The gross margin rate represents the percentage of profit obtained after deducting the production or purchase costs of goods sold, relative to the revenue generated. This rate is crucial because it reflects the efficiency with which a company produces and sells its products at a price higher than their cost.
The net margin indicates the profit remaining for the company after paying all expenses. The gross margin indicates whether the company has made a profit on its sales.
These two types of margins provide different information:
- Gross margin reveals profitability per unit sold.
- Net margin reflects the overall profitability of the company.
Consequently, the data used for calculation differ:
- Gross margin is calculated from the amounts (including VAT) of products or services. It is expressed in monetary units.
- Net margin is based on amounts after VAT, taking into account all sales-related costs. It is expressed as a percentage.
How is Gross Margin Calculated?
To calculate gross margin, use the following formula:
Gross Margin = Selling Price (excluding VAT) – Purchase Cost.
Example:
If a company produces bags with a production cost of 100 euros and a selling price of 200 euros, the gross margin will be 100 euros.
How is the Net Margin Rate Calculated?
To calculate the net margin, use the following formula:
Net Margin Rate = Net Margin / Purchase Price excl. Tax = (Selling Price excl. Tax – Cost Price excl. Tax) / Purchase Price excl. Tax.
It’s good to know that the cost price includes all expenses necessary for manufacturing a product or providing a service. In the case of a buying/selling activity, it simply corresponds to the product’s purchase price.
Example: Suppose a company specializing in buying and reselling bed linen purchases bed linen for 50 euros excluding VAT and resells it for 100 euros excluding VAT (the price excluding VAT is the selling price excluding VAT).
To determine its net margin, the entrepreneur calculates:
net margin = 100 euros – 50 euros = 50 euros
The company therefore makes a net profit of 50 euros per sheet sold.
Optimizing margins
What Margin Do You Need to Be Profitable?
For a company to be profitable, its profit margin must be high enough to cover not only the cost of goods sold but also all operating expenses.
The ideal margin rate varies from industry to industry, but a minimum of 30% is generally recommended to ensure long-term profitability:
- Retail: margins are often lower, around 10-20%, due to strong competition.
- Technology: can reach 40-60% due to relatively low production costs after initial development.
- Services: margins can be high, sometimes up to 50% or more, especially if the service offers unique added value.
What Margin Do Agencies Need to Be Profitable?
Gross margin, the king of KPIs, is more crucial than ever in a context where the agency model has changed, particularly after the Covid-19 pandemic. With the increasing importance of one-off projects compared to recurring contracts, pressure on margins has intensified. Budgets are shrinking, and decisions are being transferred to purchasing departments, which makes negotiations more difficult and imposes strict criteria for working with large advertisers.
To remain competitive, an agency should aim for a gross margin of 35 to 40%. For example, for a budget of 200,000 euros, a margin of 70,000 to 80,000 euros is expected, with the remainder going to production. In-house production or integrating freelancers helps optimize this margin by flexibly responding to client needs. In this context, adapting the scope of work to offer “less for more” can also be an effective strategy.
How to Increase the Margin Rate?
“How to increase your margins?” is probably one of the most frequently asked questions. If you find that your margin rate is lower than that of your competitors in a similar industry, several strategies can help you improve it:
- Increase selling prices: evaluate the market to determine if it’s possible to increase prices without harming customers.
- Reduce production costs: find ways to make production more efficient or buy materials at lower cost while maintaining quality.
- Optimize the supply chain: reduce logistics costs by renegotiating contracts with suppliers or optimizing delivery routes.
- Simplify business operations: streamline internal processes to reduce costs and increase overall efficiency.
We have created a purchase management system that allows us to have an overview of gross margin profitability per project and automatic tracking. We are able to aggregate gross margin estimates based on actual and forecast data, which allows us to target activity.
Techniques for Improving Sales Margins
Here are some strategies to increase the commercial margin:
- Customer segmentation: identify and focus on the most profitable customers by offering them tailored products and services.
- Cross-selling and upselling: increase the average transaction value by offering complementary products or improved versions.
Implementing these techniques helps increase the company’s sales margin, which improves its financial strength and ability to invest in growth.
Real-time Margin Tracking with Furious
An isolated calculation of the margin rate provides little added value. It is essential for any entrepreneur to track this rate regularly, both on a monthly and annual basis.
You can also compare your margin rate with that of your competitors in the same industry. Furthermore, by comparing your past margins, you can track the evolution of your performance.
You can perform this tracking yourself or get assistance. If you need help managing your accounts, you can use management software like Furious, which also offers real-time tracking. The result? You can quickly adapt your strategies to avoid losses.
