Back to: Plan for Growth

Now that you have your revenue and your COGS, it’s time to calculate your margins. A margin is the percent of revenue that’s leftover after you subtract out all the costs that were required to make your product. There are a couple of different types of margin calculations to consider, and we’ll cover them one by one. 

Gross Margin

The first margin to understand is your gross margin, which is calculated by subtracting your COGS from your revenue and then dividing by total revenue. 

Gross margin = (Revenue – COGS) / Revenue

In our example, if our revenue is $25,492 and our COGS is $4,907, our gross margin is 80.90%. If this number sounds too good to be true; that’s because it is. Remember, your gross margin only considers the expenses that directly relate to making your product, so there needs to be enough ‘headroom’ to cover all the other expenses your business might have.

Net Margin and Profit

Your net margin measures your overall profitability. It’s the same basic calculation as gross margin, but instead of just subtracting COGS you also subtract interest payments, taxes, and operating expenses like non-farm salaries, office space, insurance, marketing expenses, etc.. It’s usually the last line on a standard Profit & Loss statement. We won’t get into that level of business management in this lesson; our goal is simply to point out that there is a difference between gross and net margin, and it’s important to know which is which. 

Contribution Margin and Breakeven Points

Your contribution margin is a calculation of profit on a per-unit basis, taking into account only the directly relevant variable expenses. Knowing your contribution margin can be helpful in determining the minimum price to your kelp. It will also enable you to determine how much kelp you need to sell to start making money. In other words, contribution margin is a measure of how much each pound of kelp “contributes” to helping your business cover its fixed expenses. Because contribution margin only considers variable expenses, it will always be exactly the same (if you have no fixed expenses) or greater than your gross margin.

Based on our example spreadsheet, we incurred $3,559 in variable expenses to sell 10,643 lbs (wet weight) of sugar kelp last year. That means that each wet lb. of sugar kelp costs us $0.33 to grow. If we sell kelp at an average of $4.00 per lb, our contribution margin is $4.00 – $0.33 = $3.67 per lb of kelp. 

To estimate a breakeven point, we need to know what our total fixed costs are for our entire operation — let’s say $20,000 per year. If that’s the case, then we’ll break even when we sell $20,000 / $3.67 = 5,450 lbs of wet kelp annually.

Having a sense of roughly what your breakeven point is — even if it incorporates some estimates or averages —  is incredibly important to be able to set meaningful sales goals for the coming year. 

Of course, the usefulness of a contribution margin is limited if it’s based on an average price and cost per lb of kelp sold. Different customer types will require different formats and/or packaging of kelp. While some customers may pay more for specialty formats, getting the kelp into those formats or packaging will also require extra labor and expense on your part. If you want to get very precise, kelp sold later in the season technically has more maintenance labor and fuel associated with it than kelp sold earlier in the season, simply because of its additional weeks in the water.

For this reason, it can be helpful to look at your kelp as a portfolio of products, each with its own COGS, gross margin, and contribution margin. To calculate these values on a per-product basis, you’ll need to track sales and cost of goods sold separately, or at least include a column in your spreadsheet that allows you to easily filter to the relevant rows.

Understanding How Pricing and Sales Volume Affect Profitability 

We’ve just discussed how each product format will have different pricing, costs, and margins. And whenever a business has multiple products, there will naturally also be variance in the amount of each product sold. In such a situation, it’s intuitive that the margin of the high-volume products is generally more important to the business’s overall profitability than the margin of the low-volume products. However, if the margin of your low-volume products is significantly higher than the contribution margin of your high-volume products, it can be less clear where you should be focusing your time and resources.

Enter: margin mix. This is a calculation that combines the volume of sales made for each product with the product’s margin to show you how it affects your company’s overall profitability. It is calculated by multiplying each product’s gross profit by its percentage of total sales. Doing a margin mix analysis under different pricing, margin, and/or volume scenarios can be a helpful exercise to help you manage your pricing, processing, and sales strategies.

Let’s go back to our example farm spreadsheet and look at the Margin Mix tab. Based on our actual 2021 sales and margins, our margin is 80.75% or $1.93 per wet lb. of kelp, which led to a total of $20,584.70 in profit. Using the top table, we can see that despite the fact that our retail sales have a great individual gross product margin, we sell so little in comparison to our other product types that it only contributes 1.36% to our total gross profit margin. 

We can then try out alternative scenarios, in which we hold the total volume constant and see what happens to our profitability if we shift sales to one product or another. In the second table, we try shifting all of our restaurant sales ($11.59 unit margin) to retail ($18.72 unit margin). This slightly increases the margin mix for retail products (to 3.87%), but overall our profitability only increases by $200. So, while it might initially seem like a good idea to try to make more money by increasing retail sales, the numbers show us that it might not be worth the effort.

In the third table, though, we see what happens if we shift 15% of sales from our whole kelp aggregator ($1.61 unit margin) to our distributor ($6.51 unit margin). When we do this, we see that the distributor sales become equal to the aggregator sales in terms of importance to our total gross profit margin (both ~48%), despite the fact that the distributor sales are still less than a quarter of the volume of the aggregator. Moreover, our gross unit margin jumps to $2.63 per lb, and our total gross profit margin increases dramatically to $27,942.00 — a nearly $8,000 (36%) increase over our 2021 actuals. With this realization, it’s time to set some sales goals for the coming year!