Do you want to increase the overall profitability of your agency or company? Understanding and mastering margin rate calculation is essential. Like return on investment (ROI), 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 prices and improve profit margins. Are you ready to take the veil off profitability concepts? Follow the guide!
Definition of margin rate
What is the margin rate?
Mark-up represents the percentage of profit realized on each euro spent to produce a good or service. It is calculated by dividing the mark-up (the difference between the purchase cost and the selling price) by the purchase cost, then multiplying by 100 to get a percentage.
The term trade margin is used for business activities (purchasing and resale), while the term gross or industrial margin is used for manufacturing or service activities.
What is the purpose of the margin rate?
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 in drawing up financial forecasts.
Depending on the business sector, companies use the margin rate to:
- Evaluate the company’s business performance;
- Position themselves against competitors in the same industry;
- Identify the evolution of your business strategy, whether it is declining or improving;
- Orient development decisions toward the most profitable products;
- Calculate the company’s break-even point.
Understanding and optimizing this rate is therefore critical to the strategic development and financial sustainability of a company.
What is the difference between margin rate and brand rate?
Brand rate and margin rate are often mistakenly confused. It is important to understand the difference to avoid confusion:
- Margin rate: this is the ratio of the gross margin (difference between the selling price and the purchase cost) to the purchase cost. This rate indicates how much the company earns for each euro invested in the purchase of its products.
- Brand rate: is calculated by dividing the sales margin by the after-tax sales price. It indicates the percentage that the margin represents of the final selling price offered to the consumer.
In other words, the brand rate is used to set the selling price based on the desired margin, while the margin rate is used to calculate the margin in relation to the price of your product or service.
Margin rate calculation
How is the margin rate calculated?
The formula for calculating the margin rate is :
Margin rate (%) = (Gross margin) / Purchase cost ×100
where 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 at 20 euros and purchased at 15 euros. The gross margin would be 5 euros.
Margin rate = (5) / 15 ×100 = 33.33%.
Example 2:
For a service sold at 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 according to purchase cost and selling price, directly influencing pricing strategy and decisions of financial management.
Types of margin rates
What is the difference between gross margin and net margin?
The gross margin rate represents the percentage of profit earned after deducting the cost of producing or purchasing products sold, in relation to the sales generated. This rate is critical because it reflects the efficiency with which a company produces and sells its products at a price above their cost.
Net margin indicates how much profit the company has left after paying all expenses. Gross margin indicates whether the company has made a profit on its sales.
These two types of margin provide different information:
- Gross margin reveals profitability per unit sold.
- The net margin reflects the overall profitability of the company.
Therefore, the data used for calculation differ:
- Gross margin is calculated by taking into account 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 costs associated with the sale. It is expressed as a percentage.
How is the gross margin calculated?
To calculate the gross margin, use the following formula:
Gross margin = sales price (excluding VAT) – purchase cost.
Example:
If a company produces bags with a production price of 100 euros and a sales 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 excluding VAT = (sales price excluding VAT – cost price excluding VAT) / purchase price excluding VAT.
It is good to know that cost price includes all expenses required to manufacture a product or provide a service. In the case of a buy/sell business, it simply corresponds to the purchase price of the product.
Example: suppose a company specializing in the purchase and resale of bed linen buys bed sheets for 50 euros excluding VAT and resells them 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 then makes a net profit of 50 euros for each sheet sold.
Margin optimization
How much 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 products sold, but also all operating expenses.
The ideal margin rate varies from industry to industry, but a minimum of 30 percent 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 percent or more, especially if the service offers unique added value.
How much margin do agencies need to be profitable?
Gross margin, the king of KPIs, is more crucial than ever in an environment where the agency model has changed, particularly since the Covid-19 pandemic. As the importance of one-off projects against recurring contracts has increased, the pressure on margins has intensified. Budgets are shrinking and decisions are shifting to purchasing departments, making negotiations more difficult and imposing strict benchmarks for working with major advertisers.
To remain competitive, an agency should aim for a gross margin of 35-40%. For example, for a budget of 200,000 euros, a margin of 70-80,000 euros is expected, with the rest going to production. In-house production or the integration of freelancers can optimize this margin, responding flexibly to customer needs. In this context, adjusting the scope of work to offer “less for more” can also be an effective strategy.
How can the margin rate be increased?
“How can margins be increased?” 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, there are several strategies that can help you improve it:
- Increase sales prices: Evaluate the market to determine whether it is possible to increase prices without harming customers.
- Reduce production costs: identify ways to make production more efficient or purchase 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 procurement management system that allows us to have an overview of gross margin profitability by project and automatic monitoring. We are able to aggregate gross margin estimates on both actual and forecast data, which allows us to target activity.
Techniques for improving sales margins
Here are some strategies for increasing the sales margin:
- Customer segmentation: identifying and focusing on the most profitable customers by offering them appropriate products and services.
- Cross-selling and upselling: increasing average transaction value by offering complementary products or improved versions.
By implementing these techniques, the company’s sales margin can be increased, improving its financial strength and ability to invest in growth.
Real-time margin monitoring with Furious
Calculating the margin rate in isolation adds little value. It is essential for any entrepreneur to monitor 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. In addition, by comparing with your past margins, you can track the evolution of your performance.
You can do this monitoring yourself or have someone accompany you. If you need help managing your accounts, you can use a management software such as Furious, which also offers real-time monitoring. The result? You can quickly adjust your strategies to avoid losses.
