Becoming A Margin Clerk: A Primer on Managing Gross Profit Margins in NetSuite

Keeping a pulse on product margins is a critical task that needs active attention and mindshare from the executive team. While a pricing team may handle specific margin tactics, senior management needs to be actively involved in setting forth an overall profit margin strategy, putting in place the controls to monitor margins – with a keen eye on high volume or fast-growing products, and communicating this strategy with employee stakeholders.

Setting Forth a Strategy

The pricing strategy that your team tends to use is a function of many factors in your business, from the size of your firm relative to your competitors and the market as a whole, to the demand elasticity of your products, on through the financial goals of your organization and the specific performance metrics used to track the pricing team.

Even within a distribution business, different products might require different pricing strategies. Management teams need to work together to make sure that each of these pricing strategies are in line with the overall goals of the organization.

Some questions your team might ask when thinking about the best way to price your products for your customers:

Do we want to lower prices, and then work to cut costs to meet our margin goals? Or do we want to apply some standard markup to cost?
How often do we want to change prices? Will frequent changes pass along greater savings to our customers?
What might our competitors be doing? Do we have sufficient brand power to charge a premium on this product? Do we want to undercut the competition to drive volume growth?
What are our channel strategies? Are we charging the same price to all customers, regardless of the method through which they might order from us? Or do we expect different margins from different channels (eCommerce vs. retail vs. wholesale customers)
How well defined is our cost accounting? Which costs are in COGS, and which costs hit below the fold on our income statements?

Building Management Controls

In addition to considering all the above questions, management teams also need to ask themselves one other very important question: how will we actively manage this strategy? Put more elaborately, what combination of people, software infrastructure, and metrics will your team use to enact your strategy.

NetSuite offers a number of tools, which, combined, allow you to keep an eye on margins and execute.

Cost Accounting Tools to Build Informed Costing Models

As a tool, NetSuite offers a robust feature set to calculate and report margins for items and transactions.

Leadership teams need to consider this, because the system enables different methods of calculating gross margins, each with its own benefits and drawbacks. The system calculates gross margin from both the item record and the transaction record, and can either include or exclude ancillary items such as freight, promotions and discounts, or handling.

For example, NetSuite allows cost and price data to be stored on both the Item Record and the Transaction Record (Sales Order, Purchase Orders et al). “Shipping costs” can be stored in general terms on the Item record (“In general, it costs $X.XX to ship this product”), or in specific terms on the Transaction record (“In this specific instance, it cost $X.XX to ship this product – in fact, NetSuite pulled the shipping cost directly from the associated freight bill”). This distinction is critical, in that it enables teams to look at margins for the product as a whole, or on a transaction-by-transaction basis. It is up to management to determine if they want to take an item centric, transaction-centric, or hybrid approach to their margin reporting requirements.

Furthermore, management teams need to define the controls they might require related to “ancillary” product costs, such as freight, allowances, and discounts. For example, a management team might want a promotional cost to be booked as SG&A on the income statement (an operating expense, instead of a COGS), but want to see the cost as part of a gross margin percentage on the item or transaction level for management purposes. Managers need to define such requirements in advance, and ensure their environment is appropriately configured.

Custom Fields to Set a Target Margin

Another control managers can implement related to managing product margins is implementing a “target margin” for a particular item. A “target margin” is simply the desired gross margin at which the organization would like to see the item transact. Users can add this as a custom field to the item or transaction record, in order to be available for making margin-related decisions.

Furthermore, management teams could implement several target margins, such as “minimum margin”, “acceptable margin” and “preferred margins”. Pricing teams or management could maintain each of these fields with an appropriate target, and they could develop process workflows in NetSuite to ensure the organization is conducting transactions within the appropriate targets.

Communicating Margin Calculations

Native Gross Margin Reports

NetSuite includes some native reports that calculate gross margin; in addition, users can build searches or reports, which might expand upon this calculation and provide a more developed assessment of item or transaction margins.

Obviously, the income statement allows users to calculate gross margin for the business. This report can have an “item” filter applied to it, allowing users to see an income statement for each chosen item.

Another native report with margin calculations is the “Inventory Profitability” report. This report provides a list of all items, as well as a Gross Profit Percentage calculation. This report calculates margin by looking at the inventory value from an “item fulfillment” transaction. Teams are able to configure the system to email reports to specific recipients at planned intervals.

Saved Search Tools for Gross Margin Reporting

For more elaborate margin calculations and reporting, users can use NetSuite’s Saved Search Tool. A user can run a saved search against the item record, or against the transaction record.

On the item record, managers can calculate margins based upon user-defined costs, system-defined costs, last purchase price, or even custom cost fields’ teams might create. On the pricing side, teams can grab the base price (price for one unit of the item), or even build a weighted-average model to account for quantity price breaks offered on the item. Managers might also want to look at the gross margin for each line item on a transaction.

Similar to NetSuite’s native reporting tools, users configure Saved Searches to run on a scheduled basis, sending an email with the results at regular intervals to specified recipients. Thus, the system can send a daily email with margins for each item below a specified target, or a daily email with a list of all transactions from the previous day and the respective margin.

It is also possible to configure a Saved Search to run and email a report based upon an event. For example, suppose the margin of an item drops below its target margin of 30%. The system is able to automatically generate and send an email to a recipient, such as the purchasing manager, pricing manager, or sales rep for the item.

Users might also set Saved Searches as a reminder. For example, a pricing manager might assign an associate a “Low Margin Items Queue” reminder. When the associate clicks this link, the system provides a list of all items that recently transacted below a defined target. The user could then update the price, the costs, or the targets, thus removing the item from the queue.

Finally, users can set a product margin reported as a dashboard key performance indicator. For example, an executive might want to keep an eye on a high-volume product whose cost changes daily, thus affecting the gross margin percentage. Managers can set up a saved search to calculate the margin for this specific item, and then set that search result as a key performance indicator on the NetSuite dashboard. This allows the manager to watch the product’s margin in “real-time”, as transactions occur and the organization records them in NetSuite.