Nuthin’ but Net: Livin’ on the Margin
Business is the concept of creating value in exchange for cash. In order to do that we have to sell what we make for more than it costs to make it. The difference between what it costs to make and what we sell it for is the NET MARGIN – the net profit expressed as a percentage.
Your net margin is one of, if not the most, important numbers your business generates. You should know your average net margin cold – watch Shark Tank and you’ll hear the question, “What’s your net margin?” asked quite frequently. The entrepreneurs that can’t answer… don’t get the deal.
The entrepreneurs that can’t answer… don’t get the deal.
So how do you come up with this magic number? And what should it be?
It’s not that hard. It’s just a little basic math.
First you’ll need your Total Costs. Let’s review that:
Add up your materials. To that add your labor. Allow for overhead (10-15% of materials and labor is usually good) That’s your Cost of Goods. Multiply to your Wholesale Price. Cost of Goods plus Cost of Sales = Total Costs.
(If you’re planning for growth, add in a Cost of Sales – but that’s another article.)
Take your Selling Price (your wholesale price), minus your Total Costs. This yields your Net Profit.
Finally divide Net Profit by Selling Price.
Overhead: $1.50 (10%)
Cost of Goods: $16.50
Wholesale Multiplier: 2.2
Cost of Goods x 2.2 = $36.30
Wholesale Price = $39.00
Wholesale Price – Cost of Goods = $22.50 Net Profit
Net Profit divided by Wholesale Price = $22.50 divided by $39 = 57.69%
If I make allowance for a Cost of Sales at 15% (a potential sales rep, or trade show fees), my Net Margin drops to 42.69%. If you DON’T make allowance for Cost of Sales – raise your overhead percentage. You have cost of sales whether you acknowledge it or not, even if you don’t have a sales rep.
Your net margins are figured on a per-product basis and averaged.
42-50% is a healthy average range for a wholesale margin – in the 40’s is what you want to shoot for. Below 40% can get you in trouble.
If you’re not using a Cost of Sales figure (as in our example) your Net Margin should be higher, as it is here, to absorb those expenses.
What does this mean to you in dollars, and why is it important?
Let’s say you work your tail off and push that business up to the six figure mark. You hit $100k in revenue. That’s awesome, but how much of that $100k do you get to KEEP? After all, if you’re doing that much business you’d like to make some money, right?
If your average net margin is 42%, you should have around $42k in profit left over after all expenses out of that $100k. If your Net margin is on the 23% range though – you’ll only have about $23k left over. That’s a huge difference. And here’s where it gets interesting….
When you’re a small solo-preneur, a lot of your money is coming from that “labor rate”. You’re the maker, and the everything-else too. All the hats are on your head. So you can scoop up that labor rate for your own self for a long time. But as you scale, and you bring in other bodies: outsourcing, assistants… that’s not your money any more.
AS YOU SCALE, and you bring in other bodies… that’s not your money any more.
Now your money is coming out of that NET MARGIN – and remember, taxes.
Sure, you’ll still be doing some of the creative. Absolutely. But cut your net too fine and guess what? You’ll hit a point where there’s no money left for your check. It is very possible to do a quarter million dollars in sales and not be able to pay yourself.
Remember too, as you grow there will be expenses besides makers. Shipping. Office. Social Media. Rent. Expenses that swell that Overhead – and possibly cut into your margin.
Which scenario do you want as your goal:
$100,000 in in sales, with a 45% net margin. Approximate $38,000 after tax profit.
$100,000 in sales with a 23% net margin. Approximate $20,000 after tax profit.
One let’s you grow. One you’re spinning your wheels.
All because you cut your pricing – and your Net Margin – too close.
When you begin to scale, you live on your net. Make sure you have the margin to support it.
Want some support along the journey? Come check out F3, our(free!) kickass, toughlove Facebook support group. Apply here for membership.