Margin rate definition
What is the margin rate?
The mark-up 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 trade margin is used for trading activities (purchase and resale), while the term gross or industrial margin is used for production 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 shows how much profit is made on each sale. For entrepreneurs, margin is a key element in financial forecasting.
Depending on the business sector, companies use the margin rate to:
- Evaluate the company’s sales performance;
- Position themselves in relation to their competitors in the same sector;
- Identify the evolution of their sales strategy, whether it is declining or improving;
- Direct development decisions towards the most profitable products;
- Calculate the company’s break-even point.
Understanding and optimizing this rate is therefore crucial to a company’s strategic development and financial sustainability.
What's the difference between margin rate and brand rate?
Markup and margin rate are often mistakenly confused. Understanding the difference is important to avoid confusion:
- Margin rate: represents the ratio between gross margin (difference between sales price and purchase cost) and purchase cost. This rate reveals how much the company earns for each euro invested in the purchase of its products.
- Markup: This is calculated by dividing the sales margin by the sales price excluding taxes. It indicates the percentage that the margin represents in relation to the final selling price offered to the consumer.
In other words, the markup is used to set the selling price according to the desired margin, while the margin rate is used to calculate the margin in relation to the price of your product or service.
Margin calculation
How is the margin rate calculated?
The formula for calculating the margin rate is :
Margin rate(%) = (Gross margin) / Purchase cost Ă—100
where gross margin is the difference between sales price and purchase cost.
Practical examples of margin rate calculations
Example 1:
Suppose a product is sold at €20 and purchased at €15. The gross margin would be €5.
Margin rate = (5) / 15 Ă—100 = 33.33%.
Example 2:
For a service sold at €100 with a production cost of €70, the gross margin is €30.
Margin = (30) / 70 Ă—100 = 42.86%.
These examples illustrate how the margin rate can vary according to purchase cost and selling price, directly influencing pricing strategy and financial management decisions.
Margin rate types
What's the difference between gross margin and net margin?
The gross margin rate represents the percentage of profit made after deduction of the costs of production or purchase of products sold, in relation to sales generated. This rate is crucial, as it reflects the efficiency with which a company produces and sells its products at a price higher than their cost.
The net margin shows how much profit is left for your company after all expenses have been paid. Gross margin, on the other hand, indicates whether the company has made a profit on its sales.
These two types of margin provide distinct information:
- Gross margin reveals profitability per unit sold.
- The net margin reflects the company’s overall profitability.
As such, the data used for the calculations differ:
- Gross margin is calculated by taking into account the amounts (including VAT) of products or services. It is expressed in monetary units.
- The net margin is based on amounts exclusive of VAT, taking into account all costs associated with the sale. It is expressed as a percentage.
How to calculate gross margin?
To calculate gross margin, use the following formula:
Gross margin = selling price (excl. VAT) – purchase cost.
Example:
If a company produces bags with a production price of €100 and a selling price of €200, the gross margin would be €100.
How to calculate net margin?
To calculate the net margin, use the following formula:
Net margin rate = net margin / purchase price excl. tax = (sales price excl. tax – cost price excl. tax) / purchase price excl. tax.
Good to know: the cost price includes all the expenses required to manufacture a product or provide a service. In the case of a purchase/resale activity, it simply corresponds to the purchase price of the product.
Example: Suppose a company specializing in the purchase and resale of bed linen buys its sheets for 50 euros excluding VAT and resells them for 100 euros excluding VAT (the price excluding VAT being 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 on 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 goods sold, but also all operating expenses.
The ideal margin rate differs from sector to sector, but a minimum of 30% is generally recommended to guarantee long-term profitability:
- Retail: Margins are often lower, around 10-20%, due to strong competition.
- Technology: Can reach 40-60% thanks 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.
How much 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 evolved, especially since the Covid-19 pandemic. With the rise of one-off projects in the face of recurring contracts, pressure on margins has intensified. Budgets are shrinking, and decisions are shifting to purchasing departments, making negotiations tougher and imposing strict referencing to collaborate with major advertisers.
To remain competitive, an agency should aim for a gross margin of 35% to 40%. For example, for a budget of €200K, expect a margin of €70-80K, with the remainder allocated to production. Internalizing production or integrating freelancers can optimize this margin, while responding flexibly to customer requirements. In this context, adjusting the scope of work to offer “less for more” can also be an effective strategy.
How to increase your margin?
“How can you 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 sector, there are several strategies that can help you improve it:
- Increase selling prices: Evaluate the market to determine whether a price increase is possible without harming your customer base.
- Reduce production costs: Identify ways of making production more efficient or purchasing materials at lower cost while maintaining quality.
- Optimize the supply chain: Reduce logistics expenses by renegotiating contracts with suppliers or optimizing delivery routes.
- Simplify company operations: Streamline internal processes to reduce costs and increase overall efficiency.
We have set up a purchasing management system that gives us an overview of gross margin profitability for each project, and enables us to track it automatically. We are able to aggregate our gross margin estimates on both actual and forecasted figures, enabling us to steer the business.
Techniques for improving sales margins
To boost your sales margin, here are a few strategies:
- Customer segmentation: Identify and focus on the most profitable customers by offering them tailored products and services.
- Cross-selling and upselling: Increase the average value of transactions by offering complementary products or improved versions.
By implementing these techniques, you can increase your company’s sales margin, improving its financial strength and its ability to invest in growth.
Real-time margin monitoring with Furious
Calculating your margin rate in isolation brings little value. It’s essential for every entrepreneur to monitor this rate on a regular basis, whether monthly or annually.
You can also compare your margin rate with that of your competitors in the same sector. What’s more, by comparing it with your past margins, you can track the evolution of your performance.
You can do this yourself, or you can call on our support. If you need help managing your accounts, you can use a management software package like Furious, which also offers real-time tracking. The result? You’ll be able to adjust your strategies quickly to avoid losses.
Amaury Bataille, Managing Director, Monet + Associés
We've switched to gross margin per business unit. This is the key KPI that enables us to ensure that production sold to our customers is sufficient to absorb the costs of our business units.
