How to manage profit margins

7th April 2015

Managing profit margins is a crucial element of both controlling cash flow to keep business on an even keel and of planning for business growth.

Your profit margins will be affected by a number of influences, some of them outside your direct control. They vary significantly between industry sectors and with changing economic conditions.

There are a number of factors to consider. 

Firstly what sector you are in.  If, for example, your business is in retail the pressures on your margins will be affected by the level of your competition, the need to turn stock over as fast as possible and consumer behaviour exerting a downward influence on prices. Depending on the type of goods your business sells, turning over a high volume of stock at relatively narrow margins such as in fashion or food may be the best way to maximise profit in this sector, while longer lasting items like white goods, furniture and housewares would suggest a lower turnover of stock but at higher prices.

By contrast, the manufacturer will generally not have a high turnover of stock that can be sold at narrow profit margins.  The cost of energy, raw materials and again how much competition there is in their particular field will influence margins.  At the moment, manufacturers are benefiting from falling oil and other energy prices and falling commodity prices.

The arrival of a disruptive new technology can also affect margins.  In a recent example a 123-year-old family department store, Randalls of Uxbridge, closed its doors for the last time.  Its owner, Sir John Randall, blamed online shopping, lower footfall and pressure on margins from bigger rivals lowering costs by employing people on zero-hour contracts (which offer no fixed hours or income).

This example illustrates something that all business have in common, labour costs. For the manufacturer it may be that outsourcing component manufacture overseas to countries with cheaper labour costs are essential to protecting their margins.

The reason that maintaining profit margins is so important is that it provides the cash that allows a business to keep going, to buy stock, materials, pay for overheads and marketing.

One way to protect margins is to resist the temptation to lower prices and to sell on the quality of what the business is offering. Consider making your product different to make price comparison difficult, or where this is not possible offering an additional after-sales service of good quality.

Another key component for most businesses in protecting their margins is the quality of their management structure. Companies with focused managements that are aggressive and disciplined in processing orders, controlling inventory, as well as maintaining a culture of continuous improvement are likely to show better profit margins than those without these human assets.

Even when times are good it makes sense to protect margins in order to be prepared for the leaner times.