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The
calculation is Net Profit divided by Gross Profit x 100.
Gross
profit for a pizza shop is simply Sales minus Cost of Sales. What is the cost of sales?
The direct costs incurred in the preparation
of the pizza are the cost of the ingredients.
For
example, if a pizza shop business generates a net profit of $10,000
after
owner’s salary and overheads (eg: rent, power, staff wages, etc.), its
gross
profit result is $140,000. Thus the margin of safety is just over 7
percent.
This means
that this operation can afford to lose only 7 percent of its sales
before it
cannot cover expenses.
The
margin
of safety is a ratio that can be used to quickly compare businesses and
provides a quick health check result. Obviously, the higher the
percentage the
better.
The
margin
of safety is also important when new pizza shops open in your locality. What happens when you have new
competition? Well, put yourself in their
shoes. What do you have that they do not have? Customers.
How do they endeavor to get your customers?
Easy–they will probably use price discounting as the weapon.
Therefore,
what do we do to combat this new threat? We battle them at their own
game. We start discounting and letterbox
drops with
2-for-1 offers and other great deals.
The winner is the consumer, the loser is the pizza shop with the
lowest
margin of safety in the area. When you cut your price and start giving
product
away, you are cutting your gross profit and there is only one direction
your
safety factor is going. South.
The
pizza
shop that gets to zero first loses!
In
one of
my next articles, I will examine how we can increase our margin while
still
discounting and doing deals. Did you know there are over 50 factors
that affect
your margin in a pizza shop and price is only one of them?