Making a profit is one of the fundamental objectives of a business. However, achieving this is more difficult than it actually seems. Different factors and situations will affect how favorable or unfavorable the business’s bottom line will be.
In starting businesses, cash outflows tend to amount more than the inflows. This is because startups are still capitalizing on the equipment and facilities necessary to start operations, which are costly. In growing businesses, large outflows might be needed to invest in the expansion of operations or business capacity. In both these cases, getting negative gross profit is understandable as the business is directing company resources for its overall benefit.
However, there are cases where the management and practices of the company itself cause a negative gross profit margin. Ineffective marketing campaigns, inflated production costs, low pricing, and faulty operations are possible causes. If any of these is the case, addressing the issue should be a priority to optimize the use of company resources.
There are different ways a company can improve its gross profit margin. The company could implement strategies to increase sales revenue, decrease costs, or both. Here are a few techniques on how to ensure a positive gross profit margin for the business.
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Improve Purchasing Practices
There are different ways to reduce product costs, and one is by improving purchasing techniques. Always deal with a vendor that offers the most cost-benefit to the business. For example, the company can explore vendor options and compute which one can offer the lowest total cost without compromising on quality.
See if the company can negotiate a lower price with larger order quantities. Also, ask for discounts and offers, like free shipping.
Using computational techniques like the reorder point and economic order quantity (EOQ) formulas will help the company optimize its purchasing activities. Computing the reorder point ensures that the company does not run out of stocks and determines the ideal timing of reordering supplies. Meanwhile, the EOQ identifies the optimal number of supplies to repurchase to save on storage and delivery costs.
Be Smart about Offering Discounts
Some retail businesses offer sales discounts to increase total sales without knowing that they are actually losing because of it. When planning on offering discounts, always compute its effect on the net gross profit. The company should at least break even (i.e., sales equal costs). But if the company can make positive gross profit out of the strategy, the better.
A rising trend in e-commerce business today is personalizing customer offers. As everyone is built differently, the company must also vary its offers to minimize losing money on discounts. There is no point in offering big discounts to customers who require little convincing to convert. The company can use the customers’ purchase history to identify the ideal discount level for every customer type.
A lot of company resources typically end up in wastes, especially in the manufacturing business. Physical wastes include scraps, defects, and spoilage. Imagine paying for materials, only to end up as waste – that is money not being used effectively.
Issues like defective machines, improper inventory management, and lack of process standards could be the cause of wastage. Companies can minimize waste by addressing these issues, improving product designs, and implementing controls in production. If, after looking through the factors and implementing solutions, waste is still inevitable, find a way to transform scraps into salable products.
Review Product Costing
If the company is experiencing successive profit margin loss even when most products or services are making good sales, the issue could be with the product costing technique. Product costing is the process of determining the business costs and allocating them to come up with the product costs.
Different costing methods are applicable for every type of business. It could be that the company is using a costing method that does not fit the nature of the business and is inflating the costs of the products. What the management could do is assess the effect of each applicable costing method on the profit margin. The company should choose the product costing technique most appropriate for the business and provide the most favorable figures.
Check for Unprofitable Product or Service
Recurring negative profit margins could be an indication of unprofitable products or services. Checking for unprofitable products or services is important to determine whether it would be more beneficial to terminate them instead of costing the company.
An unprofitable product could mean two things: First, the product price does not cover the costs. If so, the management could try to increase the price. Doing so must be carefully evaluated to determine if the price increase will not affect the number of sales and the resulting gross profit margin.
Second, it could also mean that the product is not selling enough. In this case, the company should evaluate and decide whether to improve marketing strategies for the product or terminate its production entirely.
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