What is the profit margin, how to calculate it, and why does it matter?

Making enough money to run your ecommerce company takes work. Only 20% of businesses can survive in the online industry. It means that 80 of 100 firms either break even or lose money. It’s essential to monitor your profit margin to know where you are and to take the necessary steps to keep your business afloat.

Gross Profit Margin

The gross profit margin is a company’s profit after deducting all costs associated with creating and selling a product or service.

To calculate gross profit, subtract the total revenue from the cost of goods (COGS). Divide the total revenue by 100 and multiply it to get the gross margin.

The formula for Gross Profit = Total Revenue – COGS / Total Revenue (x100).

COGS is the cost of goods sold, not indirect costs like rent or office supplies.

Calculating gross profit will help you to determine if your business is profitable and whether prices should be adjusted. A low gross profit margin could indicate increasing costs to make a specific item good.

What is the ideal gross margin?

The ideal gross margin varies by industry. According to the NYU Stern School of Business, the superior gross margin for online retail is around 45.25 percent. You’ll have to charge optimal prices for your product to make an enormous gross profit.

Shopify’s profit margin tool will help you determine the best product price. This tool is easy to use and calculates the price you charge your customers to maximize profit margin.

Operating Profit Margin

Operating profit margin is the profit of a business after variable costs are taken into account, that is, indirect expenses.

Operating margin is a measure of profit margin that considers various operating costs such as utilities, rents, labor and payroll costs, advertising, and insurance.

Calculating your operating margin will give you an insight into how your operating expenses affect your business’s profitability.

Subtract operating costs from the total revenue to calculate operating profit. Divide the total revenue by 100 and divide it again.

The formula for operating profit: Total Revenue – COGS plus Operating Costs / Total Revenue (x100)

Net Profit Margin

The net profit margin is the profit of a business after all expenses are deducted, such as cost of goods, operating fees, interest, and taxes.

The formula for calculating net profit: Total Revenue – Total Costs / Total Revenue multiplied by 100

Calculating your net profit margin will help you determine your company’s success. A high net profit margin indicates that your business manages expenses well and makes sales.

Net profit margin can be used to compare your company’s performance with its competitors. The businesses must have a similar customer base and cost structure to compare.

What does a reasonable margin of profit look like?

Your company’s profit margin depends on the industry you are in, your location, and your customer base. A 10% net profit margin, for example, is considered good. A 20% margin, however, is excellent. And 5% is poor. Using your industry’s average profit margin, you can compare your company’s performance based on its gross and net margins.

How can you increase your profit margin?

You may have to accept a loss of money for some ordersIt’s okay to lose some money as an ecommerce company if you can get to know your customers better. Customers are so used to receiving mediocre service that they are blown away when a business goes the extra mile to build relationships.

How can you invest in your future customer relationships? Here are a few ideas:

When a customer returns a large item, send them a replacement immediately after they provide tracking information. Be sure to arrive at your warehouse before the product comes.

Ship customers a replacement product immediately if something cheap breaks. This will save them the hassle of returning it.

Are you unhappy with a client’s order? You can offer a partial refund as compensation for their unsatisfactory service.

The strategies may cost more initially, but they will pay off in the long run as you create a loyal and vocal fan base, improving the business’s financial health.

Reduce operating costs

Reduce operating expenses and costs to increase profit margins quickly and effectively.

You’ll need to review the costs typical to running a small business.

Look at how you can reduce your operating costs and what technology can do to help. If you offer 24/7 customer service on Facebook, and you have three employees, each working eight-hour days, you can reduce your operating costs by utilizing a chatbot outside of work hours.

Raise your prices

Many business owners fear their customers will leave them if prices increase. If you provide an excellent experience and proactively solve customer issues, even a slight price increase can make a massive difference to your business.

Consider using psychological or creative tactics when pursuing this strategy. If you sell a product at retail and wholesale prices, you could leave the retail price the same but increase the wholesale price by $5. Customers will still enjoy great deals when buying wholesale, while your business will benefit from a more significant profit margin.

Order Value Increase

The average order value (AOV) is the dollar amount a customer typically spends on each purchase at your store. AOV can be increased easily to increase your profit margin.

You can do a few things to increase the average order value.

Offer minimum order incentives. Encourage customers to spend minimum amounts. You will get better margins and an increase in your AOV. You can do this by offering free shipping with a minimum purchase amount. This is something you can set up in Shopify in minutes.

You can cross-sell and upsell items complementary to the items in a customer’s shopping cart. You can sell a bowl to mix hair dye, shave cream, and razors.

Create bundles of products. Fortunes increase the perceived value and improve shopping experiences. Create bundles that are cheaper when bought together than when purchased individually.

Create a customer loyalty program

Customer loyalty programs have been proven to increase profitability for retail and service industries. Sephora has a loyalty program with over 17 million members responsible for almost 80% of its sales.

Instead of spending money on new campaigns, create a program that rewards your customers for increasing your profit margin quickly.

Set up a loyalty program whereby customers can earn points for every purchase. After accumulating enough points, you can let them decide how to use them. They may choose to receive discounts or gift certificates to offset the cost of their initial purchase.

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