Any service company wishing to remain profitable in the marketplace needs an efficient financial management. In addition to controlling costs and expenses, it is necessary to project a healthy profit margin for the business, and calculating the profit margin per contract can be an interesting solution to this.
With an increasingly competitive market for everyone, sales instability and so many other details to worry about, maintaining a smart company and steady growth is a big challenge. To accomplish this, you need to roll up your sleeves and start setting the profit margin of your business right away.
So, in today’s post, we will teach you the step-by-step of how to calculate the profit margin per contract for your business. Let us understand in depth what profit margin is, as well as the composition of costs and investments. Let’s begin?
What is profit margin?
Basically, profit margin is the percentage of profit obtained on the sale of a product or service. Profit margin is quite different from profit: Profit is the monetary value obtained by selling this product or service, discounting the fixed and fluctuating business expenses.
On the other hand, margin is the percentage of profit expected from any sale made by the company. In other words, you can anticipate how much you will profit from your business, bringing extra foresight and security to the company’s finances.
How to calculate profit margin?
To calculate the profit margin correctly, it is necessary to take into account all expenses of production, merchandising, marketing, logistics, etc. of your company.
Only after knowing all these expenses will you be able to calculate a margin consistent with what you need to cover the costs and start making a return.
Costs are all company expenses directly related to the end service or product offered. They are usually linked to the production and procurement of goods required for the manufacture or execution of the product/service.
This includes every cost, from labor to office supplies, electricity, and even the depreciation of equipment used for the production or performance of the service.
Expenses are all costs not directly related to the product or service. These categories usually include expenses with the administrative, commercial, and marketing departments.
They also include office rentals, management software, office supplies, food and equipment aimed at the well-being of business management teams.
Although they are set aside by many companies when calculating profit margins, investments make up an important part of a company’s costs.
Investments in infrastructure, new equipment, fleet renewal, expansion and many others can have very positive effects on the reduction of future business costs, but they should not be omitted when calculating the company’s profit margin.
Net and gross profit margin: what is the difference?
Many people always confuse net profit margin and gross profit margin. However, although equally important, they are very different from each other.
Gross profit margin refers to the percentage of profit obtained after deducting the costs of performing the services rendered. It shows the rate of the return of the business, mainly pointing out, among other things, the return on investment (ROI) obtained by the company.
Net profit margin, on the other hand, indicates the percentage of real profit that a company achieves. That is: after deducting operating expenses and taxes such as Social Contribution on Net Income (Contribuição Social sobre Lucro Líquido – CSLL) and Corporate Income Tax (Imposto de Renda Pessoa Jurídica – IRPJ), you get the percentage of the amount that actually goes into your pocket, so to speak.
That is, to calculate the net margin, we can think of a hypothetical company: it grosses $20,000.00, and spends $10,000.00 with operating costs and $4,000.00 with taxation. Its net profit will be 30%.
How to calculate profit margin per contract
To make sure that your company is getting the most out of each type of service contract, it is important to establish a profitability that is appropriate for each type of activity your business performs.
In this case, we may employ some specific formulas to ensure both gross and net profit margin per contract.
As we said above, gross profit margin is the result of gross profit (after discounting the variable expenses from the total revenue) divided by gross income. Then simply multiply the amount obtained by 100 to find the percentage.
In the description, the formula will look like this:
- Gross profit margin (%) = gross profit / gross income x 100
For example, the company closes a contract for $50,000.00 and needs $25,000.00 of operating costs to perform the service. The result is a leftover of $25,000 of gross profit. Applying the formula, we will get 50% of gross profit margin.
Net profit margin refers to the business’s profitability after deducting operating expenses (fixed and variable) and taxes.
It is also not difficult to calculate – its formula is as follows:
- Net profit margin (%) = net profit / gross income x 100
Using the same example above, but taking into account that the variable costs and taxes amounted to $15,000.00, it generated $10,000.00 of net profit. Applying the formula, we will get a net profit margin of 20%, much lower than the gross margin.
Is profit margin per contract really important?
Absolutely! Calculating the profit margin per contract can bring a high performance management perspective for the business, as it makes it possible to more accurately predict the profit margin expected on the operation, and point out the contracts that are less profitable and need to be reworked.
So, is the profit margin of your business good, bad, or could improve? It can always get better, can’t it? Check out our e-Book “The definitive guide to increase the profit margin and rate of return of the company” and learn how to get the most out of your service!