Very few businesses have a single product with a single price and a fixed costs. Most businesses have many products or services each with their own margins. So how do you come up with a single measure of the profitability of your business?
The easiest way to blend margins together is a simple weighted averaged, calculated by weighting the margins by the amount of revenue for each product or service. Let’s say we sell $10,000 of basketballs with a 20% net margin and $15,000 of footballs with a 25% net margin, we can calculate our overall margin as a weighted average:
The advantage of using a weighted average is that you can easily combine the margins of any group of products or services. For example, if you sell three different products which each come with their own support service subscriptions, you can easily:
- Group all products together to measure your overall product margins.
- Group all services together to measure your overall service margins.
- Group each product with its services to measure product delivery margins.
It is important to be careful when you blend margins, since any product or service that generates the vast majority of your revenue will dominate the blended margin. If product A generates 90% of your revenue and product B generates only 10%, you may not notice changes in the margins of product B since it is such a small part of the overall.
Tomorrow we’ll get even more advanced by talking about how you can use margin calculations to understand the efficiency of individual functions of your business.
Quote of the Day: “In real life, I assure you, there is no such thing as algebra.”― Fran Lebowitz