Understanding your Profit Margin

In most cases, the number one mission for operating an online store is to make an income.  Notice, we said income – not revenue, not profit but income.

Let’s have a look at what this really means.

Running an online store has its expenses. These will obviously vary from business to business but will generally include:

  • E-commerce Platform Implementation Costs
  • Web Hosting
  • Domain Name
  • SSL Certificate
  • Payment Gateway
  • Merchant Account and Transaction Fees
  • Inventory
  • Advertising and Marketing Costs
  • Packing and Shipping Expenses
  • Website Maintenance
  • Search Engine Optimisation
  • Returns and Chargebacks
  • Sales and Discount Campaigns
  • Customer Service and other ‘people’ time expenses

Calculating your profit

To calculate your profit:

  1. First, add up the cost of the goods sold and subtract this from the total value of all your sales. This figure is your gross profit.
  2. Subtract all your operating costs – see starting list above. It is essential that all expenses incurred in operating your online store are included here. There are often many hidden costs that erode profit margins – so it’s really important your financial records are accurate. This figure is your operating profit.
  3. Now, subtract any interest expenses you have incurred, such as interest on loans that you have taken out to buy stock. This figure in your net profit before tax.
  4. Finally, subtract your taxes from the net profit before tax. Remember to include the required income tax instalments as well as applicable sales tax payments. This figure is your net income.

While the profit on an individual product may look very attractive, you can see that calculating the actual income on that item can give you a very different picture.

Calculating Your Profit - Zen Cart & E-commerce with Kerrin Hardy

Calculating profit margin

Now that’s out of the way, let’s talk about profit margin. It’s very easy to mix up the terms; however your profit and profit margin are two different measures. Profit margin is a measure of how much out of every dollar of sales a retail business actually keeps in income. A profit margin is generally calculated for a product or series of products rather than your overall business.

To calculate the profit margin:

  1. Add base cost of product and any additional costs such as packaging. You may also include a cost item here that covers your selling overheads. This figure is the cost of the product.
  2. Subtract the cost of the product from the sale price of the product. This figure is the net income for this product.
  3. The profit margin calculated by finding the net income as a percentage of the sale price.

    Profit margin = (Net income / Sale Price) x 100.

Calculating Profit Margin - Zen Cart & E-commerce with Kerrin Hardy

The profit margin is mostly used for internal use to enable you to compare the profitability of different products. Every business has different operating costs and therefore a comparison of profit margin between businesses, you can see, will actually mean very little.

How do you experiment with product pricing?  Is it always possible to find the right balance between what your customers are willing to pay and remaining competitive in the marketplace while ensuring an adequate profit margin?



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