Can Profit Margin Secure Your Next Entrepreneur Venture Deal?

One type of value that can be added to a venture is called profit margin. Profit margin is the difference between the price charged for the product or service and the cost of getting it to your customer. Value to the venture or profit margin is best determined by computing the margin's PER UNIT of a product or service.

Price per unit is simple to compute as compared to computing cost per unit. It is simply the amount per unit that your customer will pay, and this is usually readily available as a part of the purchase transaction (usually printed right on the invoice). Computing the cost per unit, however, is much more involved.

Cost per unit is really a combination of three types of costs:

Direct costs - the actual cost of producing an actual unit of the product/service.

Indirect costs - costs related to marketing and delivering that unit.

Overhead costs - a per unit allocation of the fixed expenses of the business that are not included in the prior two categories.

To some extent the allocation among these categories may be arbitrary, as long as the costs are fully absorbed, meaning that ALL costs are allocated to the product. There is virtually no substitute for knowing cost per unit. Without this information, you will always be flying a bit blind on the question of value to the venture. Incidentally, you would be surprised how many actual operating businesses do not have this information, and are therefore using a portion of their "luck" allotment to survive. Thus, it is essential to have access to a competent accountant. If you take the time to establish procedures that will yield cost per unit while your venture is relatively small, then over time, your business will become progressively better than those ventures that do not.

Value to the venture, then, is the margin per unit (price per unit less ALL costs per unit). Where these margins are large, there is room to sustain price pressure. That is, in a "price war" your venture has room to maneuver. And, if your total costs are less than those of your competitors, then you can still be making a profit, while they lose money.

In some ventures, the percentage breakdown is as high as 100 percent, 12 percent, 38 percent, or 50 percent. Other ventures have margins that drop below a 20 percent pre-tax margin. Generally, new ventures with pre-tax margins that go much below the 20 percent threshold should be classified as low margin ventures. And, if the margins are low for a new venture, the answer to Question B: Is it Valuable? The answer is NO-, which means DON'T GO ON until margins are improved.

If you are operating a low margin business your course is equally clear: Fix it or walk away. Low margin ventures are exponentially more difficult to manage, finance, and earn from. Spare yourself the experience of unproductive business failure because of the compounding problems caused by low margins per unit.

Dr. Ronald K. Mitchell is a specialist in entrepreneurial cognition, global entrepreneurship, and venture management. He developed the Entrepreneur Assessment which won the acclaimed Heizer Award for this groundbreaking research. Find out more at

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