Your margin is the amount you earn in a sale - after expenses for sale and production have been subtracted. Thus, the margin is the sum that is used to cover living expenses, rates and savings. When you calculate the percentage of the prize for a product or service that goes into the margin, you get its coverage.
What is the margin?
When a company sells a product, there are expenses tied directly to said sale. Those can be production costs, raw materials, packaging, shipping etc. A margin is the sum, that is left after all the expenses have been paid. This money can be used to pay living expenses and interest rates or save it.
The margin is therefore often the be all and end all for many companies. A sales prize is correctly calculated, if the current way of manufacturing the product pays and if it creates a profit for the company.
Not all industries or businesses work with high margins. This is, because the margin only reflects a single unit’s value, not the quantity. If you sell a lot of products, a high margin or coverage is not necessary.
The margin also does not reflect, how big the company’s surplus is. If the fixed costs, such as wages, rent for office spaces, interest rates etc., are higher than the margin, the company produces a deficit.
The margin is always found in the company’s annual financial statement.
Fixed or variable costs?
In order to calculate the margin, you need to know your fixed and variable costs for every sale. Fixed costs are costs that rarely change - definitely not on a monthly bases. These are expenses that would exist without a sale, like rent for offices, employees’ wages, insurances, loan rates etc.
Variable costs, on the other hand, are dependent on sale and production. These are the expenses that directly result from the sale of a product, such as the cost of raw materials, energy, packaging, shipping etc.
Variable costs have to be subtracted while calculating a margin. The result is the sum you can use to cover your fixed costs. Thereafter, the remaining sum becomes the company’s surplus. Keep in mind though, that the VAT on each of the products and taxes on your overall profits still have to be paid.
Coverage refers to how big of a percentage of the total sales prize the margin takes up. For instance, if you sell a product for DKK 200.00, but producing and shipping the product to your customer costs DKK 40.00, then the coverage amounts to 20 %.
Calculating coverage is relatively simple. It is done by using two formulas. The first one calculates your margin. The other one turns those numbers into percentages. The formula to calculate your margin is as follows:
Margin = sales prize - variable costs
To get the coverage, the margin then has to be converted to percent in relation to the sales prize:
Coverage = (Margin / sales prize) * 100
Is your margin too high?
The lower your margin is, the higher your financial flexibility and surplus. Hence, you should always pay attention to opportunities to lower your expenses. If possible, you can also try to find ways to lower your coverage.
There are typically three ways of lowering the coverage:
- Increasing the sales prize
- Increasing sales volume (for example by lowering the sales prize, so that more customers buy the product)
- Lowering variable costs (cheaper raw materials, production, shipping agreements etc.)
If you can not lower your margin but are still in need of boosting the company’s financial surplus, you could also take a look at your fixed costs. It might be possible to move into cheaper office spaces, work with fewer employees or restructure your debt. Keep in mind, that any kind of cutback runs the risk of damaging your company.
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Disclaimer: This overview is for informational purposes only and cannot be counted as legal advice.