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Measuring the success of your B2B small business is more than seeing how busy you are or how much cash is coming in the door. The success of your business-to-business operation can be measured by how much profit you retain at the end of the year and whether or not your profit is increasing year by year. A better approach is to use five key metrics to measure your financial well-being throughout the year. We call this financial health 101 for B2B businesses.
Tracking the Health of Your Business
Many business owners focus on the bottom line of each financial report. How much did a project cost to execute? How much money came in the door during the month? What too often happens is that they do not understand their cash flow and its ebb and flow throughout the year. The insights that business owners gain from tracking the key metrics of financial health lead to improved decision-making and steadily improving profits.
Gross Profit Margin
The gross margin of profit for B2B companies is how much money is left over after you take your sales and subtract the cost of products or services sold. Also called the gross margin ratio this number is commonly expressed as a percent of sales. A profit margin calculator can further help identify whether or not a sale was truly profitable, allowing you to create a more accurate pricing strategy moving forward.
Gross Profit Margin = (Net sales – cost of goods or services sold)/Net Sales
Multiply this ratio by 100 to express it as a percent.
How to Measure Gross Profit Margin
To measure this, business-to-business financial metrics take the money that you receive for your products and subtracts the direct costs of producing these products. These costs are materials and labor but not general or administrative business costs and do not include the costs of marketing or selling these products. You can calculate this metric across all products that you produce and sell but it is a better idea to break down your gross profit margin by individual products. This approach will give you a better idea of where your efficiencies and inefficiencies lie.
Why Track Your Gross Profit Margin?
Unless your company makes big changes in how it operates, the gross profit margin should be fairly steady. When this metric fluctuates greatly, it is typically a sign of an inferior product line or bad management practices. If you institute more automation to your supply chain you may see this metric worsen and later improve as new efficiencies take hold.
Operating Profit Margin
The next important metric for a business-to-business operation to track is its operating profit margin. This metric includes net income just like the gross profit margin but also includes all expenses of their operations excluding taxes and interest payments. Thus this metric is also referred to as Earnings Before Interest and Tax (EBIT).
How Is Operating Profit Margin Measured?
This metric gives a better picture of the financial health of your business because it includes all of the costs of doing business aside from interest paid on debt and taxes. It includes the material and labor costs of manufacturing products but also general and administrative business expenses like rent and overhead, all salaries and benefits, amortization, and depreciation.
Operating Profit Margin =
(Net Revenue – Expenses Except for Interest and Taxes)/Net Revenue
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Why Track Operating Profit Margin?
A business that sells to other businesses may be very efficient in manufacturing its products and have an excellent gross profit margin across all product lines. But, if it is spending too much on advertising, administrative salaries, and benefits, or general operating expenses, its operating profit margin will be low. You will want to track your operating profit margin and routinely compare it to the gross profit margin to keep your general and administrative costs in line.
Net Income Margin–Gross Margin
The net profit margin of b2b brands is your total revenue minus all business expenses and then divided by total revenue. Unlike gross profit margin, it includes all general operating expenses as well as taxes and interest payments. It is important to calculate both metrics for your business and compare them
How Is Net Income Margin Versus Gross Margin Measured?
In each case, the two calculations start with total revenue. Net income margin includes all business expenses from top to bottom and gross profit margin only includes the costs of producing products. You can make these calculations separately, convert to percentages, and compare them. Doing this routinely will tell you when unexpected issues affecting revenue or costs are showing up. You can also compare these percentages to industry norms to see how you compare.
Net Profit Margin = (Net Revenue – All Business Expenses)/Net Revenue
Why Track Net Income Margin Versus Gross Margin?
There are two reasons why you want to routinely compare these two metrics. One is to see how you compare to similar companies doing business with other businesses. The other is to spot when either or both of these metrics change as that will alert you to emerging problems in production, more intense competition in your niche such as from Amazon, a fall-off in your b2b customers, or excessive administrative costs. Sorting out if your problem is b2b sales, the need for help from b2b marketers, poor cash flow management, or the need for adjustment of your business model are all possible problems for which the first hint may be uncovered by tracking your net margin of income versus your gross margin.
Profitability Growth
Profitability growth is an important measure of business success. Some businesses focus on growth with the belief that profit will eventually come. Others focus on profit at the expense of growth. But, the ideal situation is that your growth of profit as measured by important financial metrics steadily grows over the years. Since you are probably not a non-profit venture, you need to know if you are succeeding in growing your profit and you want to know this in real-time.
How Is Profitability Growth Measured?
Use your gross, operating, and net profit margin calculations to measure profitability growth. Your net profit margin gives you the “big picture” while operating and gross profit margins help you see where your profit is coming from and where any problems are.
Why Track Profitability Growth?
As we said at the beginning of this discussion of financial health 101 for B2B businesses, your financial health is more than how busy you are or how much money is coming in the door. When you use these important business metrics to track profitability you will be able to spot problems and fix them, identify opportunities and exploit them, and steadily increase the efficiency and profitability of your B2B operations over the years. When you track this and find problems, you will know when to go back and look for pain points in new business ventures, devise a new roadmap, or modify the value proposition that your marketing teams use in eCommerce, LinkedIn, social media, and the rest.
Margin of Safety
In the world of accounting, the margin of safety of a small business is how far sales can fall before the business reaches a “break-even” point.
How Is Margin of Safety Measured?
This metric is calculated by first figuring out the level of sales that will result in neither a profit nor a loss for the business. Then subtract that break-even point from the current sales level and divide the answer by the current sales level.
Margin of Safety = (Current Sales Level – Breakeven Point)/Current Sales Level
Why Track Your Margin of Safety?
When your B2B operation is in danger of losing money, you need to find more customers, raise your pricing, and/or cut costs to improve your cash flow. This works out better if you see the problem coming. That is why you need to track and constantly be aware of your margin of safety. Too many promising business startups go under because they run into a cash crunch before they have established a sufficient line of credit or built up cash reserves. Tracking your margin of safety is essential for survival in many B2B operations.
Insights from Using Financial Health Metrics in Your Business
You want your business to succeed in the B2B world. For this to happen, you need to pay attention to important financial health metrics. By routinely tracking your gross, operating, and net profit margins you gain insights that lead to increased operating efficiency and profitability. By tracking profitability growth you can move up in your business niche, and by tracking your margin of safety, you can keep out of financial trouble!