Low Margin Business: Everything You Need to Know
A low margin business is one that can lead to a higher product turnover.3 min read
2. Low Margin Business Difficulties
3. Low Margin vs. High Margin
4. Gross Profit Margin Defined
Updated November 3, 2020:
A low margin business is one that can lead to a higher product turnover. Particularly, low margin products sell for very close to the price that it costs the company to either purchase or make it. Therefore, in order for the business to make a profit on the sale of its goods, it must markup the price.
A profit margin is the difference between the sale price of a product with the cost of making the product. When a company wants to sell products to the general public, it first must either make the product itself, purchase the product elsewhere, or have a company make the product for them. Either way, there is a cost associated with acquiring that product. After the company has acquired a certain number of products, it will then sell the product at a certain price. While the company might want to markup the price significantly in an effort to make a profit, the product itself might not be able to be marked up significantly, especially if a customer can go elsewhere and purchase the product for much cheaper. Therefore, if the company can’t mark it up by much, the margin might be quite low. When a company consistently sells products with little profit, it is referred to as a low margin business.
A high margin business, however, can acquire its products at a low price but subsequently sell the products at a marked up price. The reason for this is because the products might not be found in competitive industries; there might be far less of these products sold to the public. Therefore, customers are willing to spend more money on that particular product.
Low Margin Business Difficulties
Some companies end up selling products with such low margins that they are unable to make a profit on the sale. What’s more, if the company fails to sell its products, it will begin to lose money and suffer financially. It might even be forced to close its doors if it can’t keep up with the expenses and costs of making the products. With that said, low margin goods are cheaper to make and easier to sell. Some examples of low margin businesses include grocery stores and retailers. Generally, a highly competitive market will find businesses with very low margins.
Low margin companies have to sell a greater number of products to compare to the amount of money that high margin businesses make when selling fewer products at higher costs.
Low Margin vs. High Margin
Small businesses are broken down into two categories:
- High margin
- Low margin
As previously noted, low margin companies are generally those that operate in highly competitive markets. However, any business could experience low margins, particularly as a result of ineffective management. Calculating the margin can be an effective way of knowing if a company will do well financially.
However, some people choose to form a low margin type of business simply because they enjoy working in that particular industry or because it was a result of a family-owned business.
Some examples of high margin businesses would be well-known franchises, such as McDonald's, Dunkin Donuts, Starbucks, or other fast-food restaurants that are often frequented. Other high margin industries include hedge funds, law firms, condominium management entities, and jewelers.
Gross Profit Margin Defined
The gross profit margin is a way to articulate a business’s overall financial health, along with how well the price point is on each of the company’s products. You can calculate it by subtracting the cost of the goods sold from the sales revenue and dividing it by the sales revenue. Companies want to have a stable gross profit margin, overall.
An example of this would be if a company makes $500,000 in total profit on $1 million worth of sales in a given year. The gross profit margin is 50%. The net profit margin would be the net profit divided by the total sales. Therefore, if the company spent $100,000 on expenses related to such sales in order to reach the $1 million sales, then the net profit margin would be 40%.
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