The sales margin: a performance indicator to calculate... and monitor!
The sales margin is an essential indicator for managing your sales activity and profitability.
Knowing how to calculate it, interpret it, use it and improve it can be an invaluable help in starting up or developing your business in the long term.
We will also see that indicators such as margin rate, brand rate and margin ratio can be useful in refining your analyses and comparing you with your competitors.
Definition of sales margin
The trading margin is a profitability indicator that calculates the profit generated by companies engaged in a commercial activity, such as the purchase and sale of goods or raw materials that do not require processing.
It helps to :
- estimate the profit that can be generated by a product, a category of products, or an entire business,
- set prices to optimise margins
- determine your break-even point
- and drawing up a business plan.
💡 In accounting, it forms part of the intermediate management balances (sig), which make it possible to assess a company's activity and understand how its profits are made up. Moreover, accounting software can calculate them automatically.
Calculating the sales margin
The sales margin can be calculated in two ways:
- on a unit basis, to assess the profitability of each product,
- or at an overall level, to assess the profitability of your business.
Unit sales margin
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👉 Unit sales margin calculation : Unit selling price excluding VAT - Unit purchase cost excluding VAT = Unit sales margin |
▷ Example
You are in the business of buying and selling mobile phones, and you would like to know the unit sales margin generated by a particular model:
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unit purchase price (excl. VAT): €153.56
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unit selling price (excluding VAT): €322.25
→ Calculation:
322,25 - 153,56 = 168, 69
→ Interpretation:
Each model sold generates a sales margin of €168.69.
Overall sales margin
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👉 Calculation of overall sales margin : Sales excluding VAT - Purchases excluding VAT = total sales margin |
▷ Example:
You would now like to know your overall sales margin for the year generated by all your sales, given that :
- annual purchase costs (excl. VAT): €318,000
- annual sales (excluding VAT): €532,000
→ Calculation:
532 000 - 318 000 = 214 000
→ Interpretation:
The overall annual sales margin generated by your sales is €214,000.
Sales margin rate
Definition
The sales margin rate is an indicator of the proportion of margin achieved in relation to the purchase price of a product. It is therefore a reliable way of comparing the profitability of different products in a range, or of your own products with those on the market.
It would be inappropriate to compare two margins in absolute terms, because a higher margin does not necessarily mean better profitability.
There are two types of margin:
- the gross margin calculated using amounts including VAT,
- and the net margin calculated using amounts exclusive of VAT.
Calculation, example and analysis
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👉 Calculation of sales margin : (Sales margin / Purchase price) x 100 |
▷ Example:
A retailer buys a smartphone model for €100 excluding VAT from his supplier, and sells it for €239.20 to his customers, i.e. €200 excluding VAT. His trading margin is therefore €100 excluding VAT (200 - 100).
→ Calculation of the mark-up:
(100 / 100) x 100 = 100 %
→ Analysis:
He therefore makes a profit of 100% compared to the purchase price, i.e. double.
Brand rate
Definition
The mark-up ratio is an indicator that shows the percentage of margin generated in relation to sales (excluding VAT).
Like the margin rate, it provides a reliable comparison of profitability between two products or activities.
Calculation, example and analysis
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👉 Brand rate calculation : (Margin (excl. VAT) / Selling price (excl. VAT) ) x 100 |
▷ Example :
Let's go back to the previous example of our smartphone salesman, who buys one of his products for €100 excluding VAT from his supplier, and sells it for €239.20 to his customers (i.e. €200 excluding VAT). The sales margin is therefore still €100 (200 - 100).
→ Brand rate calculation:
(100 / 200) x 100 = 50 %
→ Analysis:
The seller therefore makes 50% margin on the selling price, i.e. €100 (200 x 0.5). This also means that 50% of the selling price is used to cover the company's expenses.
What about the margin ratio?
Also known as the multiplier coefficient, the margin coefficient is another way of expressing the margin rate and profitability:
- coefficient of 1 = zero margin,
- factor of 2 = 100% margin,
- coefficient of 1.5 = margin rate of 50%,
- coefficient of less than 1 = loss.
It can also be used to set a selling price. For example, for a desired margin of 50%, simply multiply the purchase cost by 1.5 to obtain the minimum selling price.
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👉 Calculation of the margin coefficient : Selling price / Purchase cost = Multiplier coefficient |
▷ Example:
A smartphone is bought for €100, and is resold for €150.
→ Calculation of the margin coefficient:
150 / 100 = 1,5.
How do you use the sales margin?
The sales margin, margin rate, brand rate and margin ratio are performance indicators that are particularly useful for steering your business and convincing investors (particularly in a business plan).
These indicators make it possible to :
- ensure that the prices set are profitable,
- calculate the ideal purchase price or selling price needed to achieve a specific profitability target,
- calculate the break-even point,
- benchmark against the competition by comparing margins with those on the market,
- monitor the profitability of the business over time,
- and make informed decisions.
Improving your sales margin: our advice
Using the margin rate, have you noticed that your sales margin is "worse" than that of your competitors, or at least lower? Here are a few tips to consider if you want to improve it:
- Reduce your purchasing costs, either by buying larger quantities to take advantage of discounts, or by negotiating with your supplier, or even by finding a supplier with better prices.
- Increase your prices by aligning yourself with your competitors through price monitoring. You can play with price elasticity, but be careful not to reach a price that your customers are not prepared to pay.
- Analyse the profitability of each product using the margin rate , to identify those that are less profitable and those that are more profitable. This will enable you to make decisions and focus on the most profitable activities.
- Improve your stock management, because it can be very costly if it's not optimal. Don't hesitate to use stock management software to help you do this.
And what about you? Any tips on how to manage and improve your sales margin?
Article translated from French