As part of our services we regularly attend Board Meetings to offer insights into the profitability of businesses and help Directors & Owners understand how they can improve the performance of their Business and ultimately profitability. One area we spend time discussing is Gross Profit and the true value of a sale to a business.
What is Gross Profit?
Simply put gross profit is the excess money from a sale left over after paying for the costs of delivery:
Sales – Cost of Goods = Gross Profit
Cost of goods are things you directly buy to deliver your sale rather than overheads, which are things you pay for to run your business such as: rent or computer software subscriptions. Supposing you are a clothing manufacturer your cost of goods would be things such as material, designers or import duty however overheads would be office rent, accountants fees or telephone lines.
What is Gross Profit Margin?
Gross profit margin is a key performance indicator, generally expressed as a percentage and is calculated:
Gross Profit Margin = Gross Profit/Sales x 100
Gross Profit Margin is a useful indicator and often used by investors to measure the profitability of not just the company, but also how that Company is performing in comparison to its competitors. Find out the industry standard for your business and compare how your business stacks up against the expected level.
Why is Gross Profit Important?
Making a sale is great but how do you know whether the sale was worthwhile to your business? We have seen scenarios where sales have been closed however once you deduct the costs of delivering the job, the true profit can be so low the sale may not actually bring much benefit to the business.
Here are some examples of the outcomes of our investigations into gross margin with some of our clients:
- Sales prices are too low;
- Sales price needs to be increased in line with production cost increases;
- Identified customers that had not been billed;
- Finding cheaper suppliers;
- Production costs have not been checked and supplier invoices have been paid in error or multiple times;
- Prompted price renegotiations with suppliers;
- Requested for bulk discounts from suppliers;
- Centralisation of purchasing;
- A business is simple not as profitable as first thought.
Analysing out gross profit is a major part of understanding your business and its true profitability. Raising sales prices or saving money on costs can improve business performance and translates into more bottom line profits so analysing your gross profit can be a worthwhile excercise.
Of course, delivering a job at a competitive price may make sense because it is an in road to an ongoing customer or gives the opportunity for upselling so it is worth taking a commercial view as well as a financial view when you do analyse your businesses gross profit.
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