Are you choosing your Net Profit Margin?
Or are you letting it happen by accident?
Dan, the Owner/CEO of a web design and digital marketing company with 5 employees, told me he has never chosen the company’s net profit margin.
“I always see what it is after we close the books for the year.”
His company’s net profit margin for the past three years was 17%, 24%, and 19%.
He came to me for help with pricing and in the course of doing that, we talked about the connection between pricing and net profit margin.
Briefly:
Net profit margin (NPM) is calculated like this:
Revenue-Costs divided by Revenue.
Revenue minus costs is your profit in dollars. Dividing by revenue gives you the percentage or net profit margin.
Knowing the NPM allows you to compare periods better than profit in dollars does.
Profit could be higher in dollars but lower when converted to NPM.
Today’s newsletter is not about pricing per se.
It is about Net Profit Margin.
Why is Net Profit Margin important?
It measures the relationship between your costs and your revenue.
A low NPM means you have to spend a lot to generate revenue.
A high NPM means you’re using your resources ‘efficiently’- that is in a way that generates far more revenue per dollar of expenses.
When Dan and I looked at the past 3 years, and the variations in NPM, we saw that the biggest change in expenses was in employee compensation. That’s neither good nor bad by itself. It indicates the need to look more deeply into that category of expenses.
In the best year (24% NPM) the company was operating with one less employee. The others were doing multiple jobs and kept revenue high, thus creating the higher NPM.
This was not sustainable, as the following year proved. When Dan filled that position, the NPM went down to 19%.
Three questions arose:
- Was that additional employee necessary?
- Was the additional revenue more than covering the expense of that employee?
- Could Dan figure out how to increase NPM with that additional employee?
–It is clear that the additional employee is necessary. It enables the rest of the staff to have a more normal workload and maintain the high level of customer service the company prides itself on.
–The additional revenue was not completely covering the cost of that additional employee. If it had been, NPM would have remained at 24% like the previous year.
–They would have to increase volume and/or prices to generate a higher NPM.
Volume or Prices?
The company—any company—has no control over volume. It does its best to attract new and repeat buyers with your marketing. Your sales team works hard to turn those people into buyers. You retain them with customer service and desirable offerings. But you cannot control who and how many respond.
On the other hand, you control prices 100%.
No:
- competition doesn’t affect your prices.
- bargain hunters don’t affect your prices.
- industry doesn’t affect your prices.
Nor does the economy, or the size of your market, or any other external factor.
Only you.
Set your NPM
Setting a target (required) Net Profit Margin provides the foundation for your pricing.
It tells you you cannot go below a certain amount, and it shows how increases will increase NPM.
NPM helps you think through your company ecosystem:
- offerings
- marketing and sales
- service
- retention efforts
At first Dan was amazed at the power of a target NPM.
Then he got excited about how his target NPM will help him make decisions.
He told me that he now “knows his numbers” in an entirely different way than he ever has since he launched 9 years ago.
And his favorite number is his company’s Net Profit Margin
Dan says:
“Your recommendation to start with our NPM goal and work to achieve it is changing my life!”
The company’s fluctuating NPM caused real constraints on Dan’s life both as Owner and CEO of his firm and on his personal life.
By achieving the target NPM, he’ll have money to invest in the company and more money for himself and his family.
Dan wasn’t thinking about Net Profit Margin (“that’s just for the accountants”). But now he is and it’s making a huge difference.
If you’re thinking it would be nice to get some life changing differences into your life, text NPM to 703-801-0345 to set up a call.
