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Understanding Margins

Many sales people including Sales Managers and even some Sales Directors are uncomfortable with detailed margin discussions. This usually comes as a result of spending a long time in one industry that expresses ‘profit’ or ‘margin’ in a particular way. ‘POR’, ‘Mark Up’, Multiplier’ ‘Margin’ and, of course, ‘profit’ are all ways of expressing the same thing and whichever one you are used to it’s a very short step to familiarising yourself with the others.

You will hear other industries expressing their earnings in all sorts of ways and sometimes even hear about a National Account that works its margins with a hint of ‘black magic’ ~ ‘black magic’ that means you always lose out.

There is no black magic associated with the workings of ones profit (unless you’re an accountant!). Simply put IT ALWAYS BOILS DOWN TO THE SAME THING. That is how much cash you and your customers make from dealing with each other.

The confusion often arises when we talk about this cash as a percentage and it’s not clear what the percentage is of …. Also when talking about profit the word ‘margin’ often creeps in. In the context of profit, the word margin simply refers to ‘the difference between cost and selling price’.

Confused yet … ?

To start with, when talking profit margins ALWAYS isolate the cash sums involved, Cost Price, Selling Price, VAT amount, and of course the profit.

EG

The Retail Selling Price of the item is £10.99

You sell to your customer at say £5.00

If applicable**, take off the VAT by dividing the RSP by 1.175

£10.99 divided by 1.175 is £9.35

Then take away your selling price

£9.35 minus £5.00 is £4.35

Therefore on each item sold your customer makes £4.35 and gives the tax man £1.64.

Simple so far, but this is where the confusion sometimes comes in. Many customers will express that profit of £4.35 in a different way. Most will express it as a percentage ~ but a percentage of what?

The most popular expression is ‘Profit on Return’ or ‘POR’. It’s worth clarifying if this ‘Return’ (ie what the Retail Selling Price is) is including or excluding VAT as it makes a difference. Some very worthy sales people have been caught chasing the wrong figure.

EG

If we use our original example:

The Cash Profit of £4.35 expressed as a percentage of the RSP including VAT (£10.99) is 39.6%

(Calculated by dividing £4.35 by £10.99)

The cash profit of £4.35 expressed as a percentage of the RSP excluding VAT (£9.35) is 46.54%

(Calculated by dividing £4.35 by £9.35)

Some customers / industries choose to talk about their cash profit as a percentage of their cost price. They ‘mark up’ items to calculate what they will sell at. Then add VAT.

EG

In this instance the cash profit of £4.35 would be expressed as a percentage of the cost of £5.00, ie 87.06% (calculated by dividing £4.35 by £5.00)

One or two industries talk about ‘multipliers’, they simply multiply their cost by x and then add VAT.

If you’re confused you MUST get a grip of this, it’s the difference between a good deal and a bad one.

** The VAT belongs to the tax man, so first take it off the selling price if applicable (some products like food and kids clothes are ‘0’ rated so do not include VAT when you buy them).

If you think you’ve got it, have a play with the 10 quick questions below, we’ll publish the answers in our first newsletter so make sure you’re registered to receive it …

You sell the customer at £1.27, he / she wants to mark up by 100% and needs to add VAT.

  • What will be selling price be?
  • What will be the profit expressed as POR (Ex VAT)?

Your Customer sells a product at £49.99 inc VAT and makes 45% POR (inc VAT)

  • How much cash profit does he make?
  • What is your selling price?

You customer buys from you at £0.45, and uses a 4 x multiplier. He is working with ‘0 rated’ goods.

  • What is his POR?
  • What would his mark up be?

Your customer says ‘I want to sell it at £4.99 and make 40% (£4.99 is inclusive of VAT).

  • What should your first question be?
  • How much is the VAT ?

Your price list says the product retails at £1.99 excluding VAT and the customer makes 33%.

  • What is the mark up?
  • How much cash will they make?