Margin Analysis is the art of analyzing how much profit you are clearing after expenses. This exercise is extremely important for all businesses to take part in if they want to curate a sustainable, healthy enterprise. I could write a novel on the subject, but for the sake of everyone's time, we'll keep it short.
Whether you are a service based business or sell products, you need to know your margins.
Here are the basics.
Your margins will vary by a number of factors like SKU, customer, and sales channel. There are so many factors that play into creating a finished good. From ingredients, to raw materials, to shipping, weather, you name it. The key is to track these costs, and analyze them obsessively so that you can streamline expenses and capitalize on any honey holes where you are successful (then replicate this so you are successful in other areas too!).
Knowing which product costs what in the overall story of your products means a better understanding of which products are more profitable than others. It may also help identify which supplier is most cost effective, if you are using more than one manufacturer to produce your products.
Any seasoned omnichannel CPG brand will tell you that a good strategy is not to blast any and all sales avenue. They will also tell you that your online store/D2C is typically your best bet for profit margins. This is not the case all of the time, so studying all of your sales channels to see which one(s) are most profitable means you can double down on the ones that are successful, and you can learn what factors are at play that make each successful or not-so successful. Learn, adjust and operate accordingly.
Who shows up and brings you the profit you desire? Is it a slew of repeat customers ready to snag the latest iteration of their go-to product of yours? Is it a really solid dealer or distributor? Maybe bundling popular repeat product purchases makes sense to snag that repeat purchase all up front, versus waiting for a reorder? Knowing the habits and preferences of your best customers also means you can market your products better to them asa well.
There are a lot of variables that go into providing a quality service that can go unaccounted for if you are always "going the extra mile" for (what you think) is your most profitable customer. Many times, when the accounting hits the paper and you begin to track the costs associated with your activities, the true picture of your business appears. I'll give you a hint:
Labor is always your biggest spend as a service provider. Starting there is always a good first step.
Since you digging into these metrics is all part of your labor spend, I will give you a free pass to invest some of it into learning this concept. Then, I will urge you to spend that in outsourcing this to a pro, like Accountfully which is equipped to keep your margins at the forefront of our activities while you spend your time earning more cash.
As a service business, you need to be assessing your margins across the following areas of client, job, staff class and department.
Client Margin: (Client Revenue - Client Costs) / Client Revenue
Track the revenue generated from each client. This is usually straightforward but requires consistent invoicing and payment tracking.
Allocate both direct and indirect costs to specific clients based on the resources used. This could involve tracking the time spent on each client’s projects and applying an hourly rate that includes both direct labor and a share of overhead.
Job Margin: (Job Revenue - Job Costs) / Job Revenue
Break down costs by specific jobs or projects. This involves detailed time-tracking and expense management systems to ensure that every hour worked and every resource used is attributed to the correct job.
Allocate revenue based on the specific job or project. This often involves milestone payments or time-based billing. If you are not tracking time, start now to understand this better.
Staff Class Margin: (Revenue by Staff Class - Cost by Staff Class) / Revenue by Staff Class
Different staff classes (e.g., junior vs. senior employees) will have different hourly rates. Ensure that the cost of labor is accurately reflected based on who is working on the job.
If applicable, break down the revenue generated by different staff classes. For instance, senior staff might command higher billing rates.
Department Margin: (Department Revenue - Department Costs) / Department Revenue
Allocate overhead and shared costs (like administration) to different departments. This can be done based on headcount, revenue generated, or another relevant metric.
Track the revenue generated by different departments to understand which areas of the business are most profitable.
Once you are tracking and assessing these margins, you will need to review and refine your practices; from billing or workflows to ensure profitability. This exercise can be focused by doing the following:
Develop reports that provide a clear view of margins across different dimensions (client, job, staff class, department) to facilitate decision-making. Accountfully uses Fathom to show these metrics in a visual dashboard.
It comes down to accurate and consistent margin analysis. This requires a knowledgable accounting team matched with the right financial software to expertly understand and apply this data. The end goal is to produce a more streamlined, more profitable business. The best place to start is by taking the time to pay attention to this and start learning where you sit when it comes to margins.
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