Should your profit be based on sales or costs?

Almost all small businesses in Kenya have varying levels of revenue. This can make it difficult to assess your performance but it still has to be done.

One guide for the job is to have a range of your acceptable profits and returns. This way you can know if you’re​ in line with your industry and ahead of your competitors. Different businesses perform differently so you must be careful about beating yourself about your performance. How often have wealthy people on the internet with house helps, drivers, personal assistants, errand people and interns guilt-tripped you about how we all have 24 hours in a day to make things happen? Of course, you must still manage time wisely.

This difference in context, around us, should also be used in measuring profit performance. You need this to know what price to set, how much to sale, who to get your supply from (drugs joke) and how much to pay yourself.

Lucky for you, there are two ways to measure profitability. You don’t need to reinvent the wheel. You can base your profits off of sakes or you can do it off of cost of production. Do you know what these mean? Do you know which is ideal for what occasion? Let’s take a brief look.

Markup vs Margin

The profit margin is more commonly known. You can calculate it on your gross, operating and net profit. For example, if your revenue was 100 and your cost of production was 80, you would subtract cost of production from revenue (100-80 = 20) and divide that by revenue (20/100 =0.2). If you multiply by 100 you get a 20% profit margin.

This means you keep 20% of your sales. The profit margin’s emphasis on sales means you increase it by focusing on more sales. Therefore, your profitability problem could be an issue of how effective you are in promoting your business. Do you have a marketing strategy or do you just change it? Do you have specific goals from advertising your work or are you satisfied by how cool good adverts are?

On the other hand, you may be the type of entrepreneur who feels your challenges are because of internal problems. One such problems is the cost of production. The markup is for you.

Using the same figures from above, you subtract cost of production from revenue (100-80 = 20) and, instead, divide that by cost of production (20/80 = 0.25). If you multiply by 100 you get 25% markup. This means you are selling at 25% over the cost of production.

Markup is especially useful for new businesses or a new product where control of costs remains the important thing. In fact if you set a fixed markup percentage you would stay above the cost of doing business and survive till, one day, you can focus on revenue growth.

You’ve seen that they read differently for the same level of business performance. This should aid you into not thinking that a higher markup means greater profitability. You have to account for both readings when setting your prices, even if your management style may favor one measure over the other.

Isn’t it unnecessarily much work to have to calculate each of them? Especially, since you also record forecasts of future performance. You’re lucky twice. You don’t need to calculate both margin and markup to make comparisons. You only need to do the one you favor. You can then use the Markup-Margin tables, freely and widely available online, to decide on your acceptable profit levels.

Ok, here is a summarized table we made:

Markup Margin
15% 13%
20% 16.7%
25% 20%
33.3% 25%
100% 50%