Wednesday, 8 June 2016

The Bean Counter - Know your Profit Margins

by Guild Member Helen Gould BA (Hons) CIMA Dip MA

Love him or loathe him, Lord Sugar’s business acumen concerning ‘Smell what Sells’ and knowing your profit margins are the key to success, no matter the size of the business. All too often, the familiar statement said to me by my fellow craft fair stall holders is “well I’ve managed to cover my table fee today, so that’s ok”.  Clearly, there are many crafters that should pay attention to Lord Sugar’s no nonsense approach to gaining business acumen.

So you know what sells, but what about the profit margins? Well in fact there are three profit margins to think about, Gross, Mark-up and Net. Let’s look at the Gross profit margin first, with the aid of an example to explain the accounting concept.

Mary-Jo runs a small business selling handmade knitted lamb’s wool baby blankets that she sells for £15.00 per blanket. Each ball of wool costs £3.00 and Mary-Jo uses 2 and a half balls per blanket which is costed as £3.00 x 2.5 balls of wool used = £7.50 (known as the Cost of Sale). So to work out Mary-Jo’s Gross profit margin, the calculation is as follows;

Selling Price              £15.00
Less Cost of Sale       £7.50
Gross Profit Margin   £7.50

Great, Mary-Jo will make £7.50 gross profit for every blanket that she sells but this is just half of the activity behind making the sale. More often than not, the Mark-up % margin is often forgotten about and yet it is the key to knowing if you have not only covered your costs, but made an overall profit on the item that you have sold. Let’s look at the Mary-Jo’s business to see how the Mark-up % margin is calculated. Mary-Jo has timed herself as to how long it takes to knit one blanket, which is two hours and she knows that she cannot pay herself as per the living wage rate of £7.20 (as at 2016), so she has worked out that she can afford to pay herself £3.00 an hour and can now work out what is known as a Labour cost of producing each blanket. This is costed as £3 per hour x 2 hours taken to make the blanket = £6.00 Labour cost. Now we can work out Mary-Jo’s Mark-up % on the baby blanket. The first step in the calculation is as follows;

Gross Profit Margin        £7.50
Less Labour Cost            £6.00
Net Profit                        £1.50

So in order to find the Mark-up profit margin, the final calculation needs to be done as follows;
Net Profit £1.50 divided by Selling Price £15.00 = 0.10 x 100 = 10%
So Mary-Jo now has a true insight on the costs behind the production each blanket that she makes and this is a useful calculation to perform as the starting point to deciding whether or not the products that are made will generate enough Revenue (Sales) to cover all the costs of running the craft business.
At the beginning of this article, I mentioned that some craft stall holders are happy when they have just covered their table fee, but as the conversation develops, it becomes clearer to me that they have not taken in to consideration all of the costs of the day, that are referred to as operating costs of the business. We can use the Mary-Jo example to test how this actually works in the situation of table hire fees as follows;
Mary-Jo decides to take a local craft fair pitch at a cost of £15.00 for the day (4 hours exhibition time and 1 hour of setting up/packing away time). Mary-Jo pays herself a wage of £3.00 per hour, it will cost her £5 in fuel to get to and from the venue and she plans to spend £3.00 on refreshments for herself during the event. All of these costs are operating costs that will need to be charged to the business. In order to plan the day, Mary-Jo will need to set herself a sales target so that she will know when she has at least covered all of her costs from attending the event. An easy way of working out what the target should be is to lay the costs out first as follows;

Stall Fee                            £15.00
Fuel                                   £5.00
Refreshments                    £3.00
Time at Fair                      £15.00     (£3.00 x 5 hours) 
Total Operating Cost        £38.00

Now the Sales target can be set by dividing the operating cost and the net profit from the baby blanket. The calculation is as follows;
Total Operating Cost £38.00 divided by Net Profit £1.50 = 25.3 Rounded to 26 blankets
Mary-Jo will have to be very confident that the event will be well attended and that her selling face to face skills are strong in order to sell £390 worth of baby blankets to make that all important Net profit for the day, which would need to be;
Sales (Revenue)                      £390.00
Less Cost of Sale (26 units)    £195.00
Gross Profit                             £195.00
Less Expenses;
Labour Costs (26 Units)         £156.00
Operating Costs                      £38.00
Total Expenses                       £194.00
Net Profit                               £1.00

By understanding the Gross, Mark-up and Net profit margins of your craft business, you can then decide if the business stays as a second job/hobby. Or if it really can become your main dream job with the rewarding benefit of working for yourself and the luxury of planning when you work to create that all important work/life balance.

If you have any accounting queries please email us at and we will pass them onto Helen.

Helen is a member of the PCG and you can visit her here

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