If you aren’t in accounting or finance, you may think that you don’t need to understand financial terms. After all, they are the experts, so what can you possibly gain by understanding your company’s financial numbers?
But, the thing is, everyone in your management chain is thinking about margin. And, your job is to make your manager’s life easier, so if you understand financial concepts, you better understand what is driving your management team’s decisions. And, when you understand why your management team is making the decisions they make, you put yourself in a better position to make their life easier.
You don’t have to be an expert – I agree – leave that to the accounting department. But, if you have an understanding of the basic concepts, you will be more successful in your career. You will also be able to make better decisions for yourself because you will be able to anticipate what your management team will do next.
The concept we are going to cover this week is margin. Margin is the amount of money left after you pay for all the cost.
Revenue minus cost equals margin.
In personal terms, we call it savings. Your revenue – your hourly wage or salary – minus your costs – taxes, rent, food, ballet lessons, orthodontist bills, car payment, and that Amazon Prime fee. What remains is your margin, or savings. For companies, it is the same. They take in revenue through sales and they have expenses. What is left over is margin.
And, as you can probably guess, the goal of every management team is to have the highest possible margin. So, as your management team makes decisions part of their decision involves understanding the impact on margin. I don’t mean to give the impression that it is the only factor, or the most important factor. Every business and every leadership team is different, so how your management team makes decisions will be unique. But, they are considering margin, so if you can understand this aspect of your company, you will be better able to understand one of the levers in your management team’s arsenal.
Margin, on the surface is a fairly easy concept to understand, but I’ve found over the course of my career that people really struggle with it. I think it is because there are so many factors that influence it. It is absolutely relative to the specific situation, so you must always understand the larger context of the business in order to understand the impact on margin.
To help paint a picture for you, I’m going to use a familiar example that we can all relate to. We are going to assume the roll of a hamburger fast food restaurant. Now, our restaurant has a standard burger that is made up of a bun, meat patty, lettuce, pickle, tomato & ketchup.
When a customer walks into the restaurant, they can see the price of this burger up on the board. They pay $2.99 for the burger and that $2.99 becomes our revenue.
We have a cost associated with delivering this burger to them. 1st, there is the cost of the ingredients. The bun, the meat patty, the pickle, tomatoes, lettuce, and ketchup. The accounting department tells us that the cost of these ingredients is 75 cents. So, we take in $2.99 in revenue and we spent 75 cents on the ingredients. You might think that the margin is 2.99 minus 75 cents. But, keep in mind that we also paid someone to make the burger. We also paid for the electricity to operate the grill. We paid rent on the building. We paid the manager to oversee the person who made the burger.
So, you have to include all of these costs. For our burger joint, let’s say all of these costs add up to $2.50. So, we sell the burger to our customers for $2.99 – which is our revenue. And it costs us $2.50, which means our profit is 49 cents.
Again, margin is what is left over when you subtract cost from revenue.
Now, let’s take a look at some of the ways margin can be impacted. Let’s say a customer comes in with a coupon for 50 cents off their burger. This means that our revenue is going to go down from $2.99 to $2.49. But, our cost didn’t change. It still costs us $2.50 to produce and deliver the burger. Now, the margin is $2.49 minus $.50, or negative 1 penny. So, when revenue goes down but costs remain the same, margin also goes down.
Think about ways that might happen at your company. What are the scenarios where revenue might decrease without costs changing? What is the equivalent of a 50 cent off coupon for your business?
Let’s look at another example. A customer comes in and orders a burger and asks or extra pickles. They don’t have a coupon, so they are paying $2.99 for the burger. This means that our revenue is $2.99. But, they asked for extra pickles. The cost of adding extra pickles to the burger is 5 cents. Now, the total cost has gone up from $2.50 to $2.55. So, even though our revenue stayed the same, our cost increased. This makes our margin 44 cents. $2.99 revenue minus $2.55 cost is 44 cents. Our margin has decreased from 49 cents to 44 cents.
Think about ways that might happen at your company. What are the scenarios where costs might increase? What is the equivalent of extra pickles for your business?
What if a customer walks in and orders a burger and tells you to hold the pickles? Sine we know it costs 5 cents to add pickles, we know that it saves 5 cents to hold the pickles. So, the cost of the burger goes from $2.50 to $2.45. Margin is now 54 cents. $2.99 in revenue less the reduced cost of $2.45 gives us a bigger margin of $2.54.
Think about ways that might happen at your company. What are the scenarios where costs might decrease? What is the equivalent of holding the pickles for your business?
Understanding the different levers that impact margin for your company helps you understand how healthy the business is. It may also help you understand ways that you can help impact margin by either improving revenue or reducing cost so that margin is increased.
There are a lot of various factors that can influence margin, and if you’d like to explore the topic more, I encourage you to check out our financial acumen curriculum, which is a collection of all of our episodes that explore the topic of company financials.
So, your homework this week is to spend some time thinking about your company’s margin. What are the things, like coupons, that impact revenue? What are the things, like extra pickles that impact the cost? Can you see how your management team is making decisions to move these levers in order to help improve margin for your company?
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