At the end of the day, owning and operating a successful business requires you to think about the amount of money it’s earning.
While you may love the work you do and care most about the customers, understanding profit margin and markup will ensure you’re running a stable business that can last.
Your profit margin will be unique to your business and look different depending on the types of services you offer.
Before we dive into the details – let’s quickly define the terms profit margin and markup…
What does Profit Margin mean?
Profit Margin – is one of the most commonly used financial ratios across all businesses and industries. If calculated correctly, the result of the profit margin formula will give a percentage that shows how profitable the business is. It will also help you understand where you can make changes or improvements to your pricing structure or business model.
What does Markup mean?
Markup – is the percentage that a company will increase the price point of their product (or service).
When was the last time you analyzed your prices?
Making sure you’re marking up products and services precisely is a great place to start if you want to increase profits…
Types of Profit Margin
Gross Profit Margin
The Gross Profit Margin (GPM) is used to calculate the profit margin as income remaining after the Cost of Goods Sold (COGS). This is the most basic way of stating a business profit margin – as it only includes the cost of materials and labor.
This is a good figure to calculate if you’re looking to figure out the percentage of revenue after factoring out the cost of production.
GPM% = (Net Sales – Cost of Goods Solds / Net Sales) x 100
Operating Profit Margin
The next step would be to calculate the Operating Profit Margin (OPM). On top of accounting for the cost of goods sold and labor – it also accounts for any other overhead or operating costs.
Grouping in the other daily expenses and assets the business has allows you to get an even more accurate view of a business’s operating profit margin. It’s a great way to see if any day-to-day expenses can be eliminated from your budget.
OPM% = (Operating Income / Revenue) x 100
Net Profit Margin
The Net Profit Margin (NPM) calculates the revenue that is left over after all costs of goods sold, labor, other operating expenses, taxes, insurance, debts, and additional streams of income are added in.
This is the truest form of profit margin, as it includes all aspects of a business when being calculated. The number of expenses will look different for each company and depend on the industry you work in.
NPM% = (Net Income / Revenue) x 100
High-Profit Margin vs Low-Profit Margin
Which one is better?
It might seem like a high-profit margin in a markup is always better, but in service and maintenance, things are not always clear-cut. Depending on the services you offer, you could have a High-Profit Margin or a Low-Profit Margin (or even an average profit margin).
More often than not, some jobs will fall within the first (e.g. heat pump installation), while others in the second (service checks).
But after calculating your profit margin for each specific job you offer, you should be able to get a better sense of how you compare – first and foremost to your costs – and then to similar businesses in the industry and area. Never start with the latter, as you don’t know what corners your competitors might be cutting in order to offer lower prices.
Taking the guesswork out of how to improve your HVAC profit margin can be tricky – try these tips to get your profit margin where you want it to be.
Having a high-profit margin means you are most likely in a business that offers high-end services, where the degree of expertise is worth more than the actual labor costs. Sometimes, this expertise translates as brand value.
Think about high-end designer jeans versus a classic pair of Levi’s. The product is the same, but one retails for $100, the other for $1000. You might think no one would pay $1000 for a pair of jeans, but companies would stop making them if there wasn’t a demand, so somebody must be, right?
Generally, high-end products like these often come with a low manufacturing expense, as they are custom-made to order or don’t require a large overhead. For service and maintenance companies, there are usually two main strategies if they want to switch to high-profit margin jobs:
Brand the business as premium and charge accordingly (but only if you operate in an area with affluent customers who can afford it)
Develop your expertise to include more niche services that attract affluent customers, such as historical home renovations
If a service is cheap or easy for a company to deliver, but sells at a high price, it will end up with a high-profit margin. While this is great – these companies aren’t going to be swamped with demand and need to make a large profit on each job in order to make a similar profit to low-margin businesses.
Having a low-profit margin percentage doesn’t mean you don’t have a successful business. You might be the kind of business that focuses on low-margin, high-frequency jobs such as servicing installations or offering safety certificates. As long as you can fit enough of these jobs into your schedule to make a profit, you’re still running a successful business.
Or if your business has very high operating costs, you could end up with a low-profit margin. This is not an ideal situation, as high operation costs that are out of your control (e.g. gas prices, parts prices, etc.) can easily tip you into the red if you’re already operating at lower margins.
Remember, if you’re going to compare your business’s profit margin with another, make sure it’s within the same industry. It would be even better to compare to a business that has a similar model to yours as well and operates in the same area.
Check out Ruth King’s advice on how to prioritize profit!
How Markup can Increase Revenue
Markup is the percentage that a company will increase the price point of their product and/or service.
Before we talk about how much to mark up your product – let’s take a look at the markup formula. It’s the difference between the product or service’s sale price and the cost of producing it – represented as a percentage.
Markup % = [(Sale Price – Unit Cost) / Unit Cost )] x 100
For example: [($150 – $125) / $125)] x 100 = 20% markup
A unit that costs $125 to make and sells for $150 will have a markup of 20%.
When it comes to marking up the service your business produces – you need to think about what you want your profit margin to be and how much revenue you want to make!
If you want to make at least 40% revenue on all the jobs you complete, plug your numbers into the formula to figure out how much you should markup to hit your revenue goals.
The Importance of Inventory Management
One of the best ways to make sure your business is operating efficiently is to keep proper track of your inventory.
Using software to keep track of your inventory will allow you to manage stock as it moves across your business, organize returns, streamline ordering, and empower your team to provide unmatched customer service.
Utilizing profit margin and markup and making sure your prices are where they should be is a massive part of running a successful business!
Properly managing your inventory will help you immensely on this journey.
Download our free pricing guide to take the information with you and make sure your business is setting its prices correctly.
Thanks for checking out the Commusoft blog - I’ve been helping business owners improve their strategies for a few years now, so I hope you were able to take something away from the content I’ve written. Feel free to continue exploring the blog - or reach out to us with any questions!