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Gross profit margins are not exactly stimulating dinner party conversation. But when it comes to managing the finances of your business, having a clear understanding of your gross profit margin is essential. In this article, we’ll start by unpacking the basics and demonstrate how you can calculate it for your business. Let’s dive in!
What Is a Gross Profit Margin?
A gross profit (GP) margin is a percentage that shows the profitability of a small business’s service or products. Basically, it answers the questions, ‘How much are you actually making on what you sell?’ This calculation is based on the business’s total revenue and cost of goods sold. The point of a gross profit margin is to show you, as a business owner, how much money is left over after you take away the cost of making, marketing and selling your product or service. It is important to your income statement. It’s also important to know what you are putting into your business and what you are getting out of it, banking tools can help you track your money’s movement.
The GP margin is important to your income statement. Both of these financial documents help you track what you are putting into your business and what you are getting out of it. Transparency is key, and small business banking tools can help you keep a close eye on the numbers that impact your GP margin.
What Is a Gross Profit vs. a Gross Profit Margin?
A gross profit and gross profit margin measure the same metric. They both tell you how much are you making in profit after you take away the cost of the product or service you provide. The difference between the two is really simple; a gross profit is the dollar amount while a gross profit margin is a percentage.
What Does the Gross Profit Percentage Tell a Small Business Owner?
As a business owner, the more you know about your small business’s financial health the better position you will be in to grow and improve your business. One of the key metrics that can help you understand where your business stands financially and where you might need to make adjustments is by measuring gross profit margins.
Measuring your GP margin will tell you how much money your business earns after you deduct the cost of making and marketing your product or services.
If you can, try to measure your own GP margins against your competition or the industry standard for your business. If other businesses have a higher GP margin than your business, this demonstrates that their operation is more efficient. You might want to look more closely into what they are doing differently.
Once you’ve worked out your gross profit margin, you’ll be able to see whether you are making enough profit for your business to be sustainable and whether you have the ability to grow over time. If your GP margins are too low, you will need to adjust your budget or operating costs. Maybe the materials you are using are too expensive and you should do some research to find something more cost-effective? If your margin is too low, you might also need to consider charging more for your product or service.
How to Calculate Gross Profit Margin
To calculate your business’s gross profit margin, all you need to do is take the total revenue for a given period and subtract the total cost of goods sold for the same given period. Then you take the result and divide it by the initial cost of total revenue. So the formula looks like this:
Gross Profit Margin = (Total Revenue – COGS) / Total Revenue
If this is sounding a little complicated, don’t worry it’s really not. Here’s an example;
Say your business made $60,000 in a month and you spent $15,000 making your product and running your operations. Here’s how you would calculate your gross profit margin.
60,000 – 15,000 = 45,000
45,000 – 60,000 = 0.75
0.75 x 100 = 75%
And that’s your gross profit margin! 75% percent! While that is a really strong margin, remember that these calculations only include the direct cost of making a product. They do not include other expenses such as rent and loan repayments.
Your gross profit margin should remain fairly stable throughout the life of your business. Extreme fluctuations can be signs of mismanagement or a significant increase in the cost of materials. For example, if your profit margin is 5% one month and 25% the next, you will definitely want to look more deeply into what could have caused such an increase.
Now that you have a clear idea of what a gross profit margin is, and how it can benefit your business, make a habit of doing this calculation once a month to keep tabs on how your business is performing. This will help you catch issues before they have a chance to damage your business’s financial health.
Managing your finances can be time-consuming. That’s why we encourage business owners to make use of the NorthOne mobile banking app. NorthOne can make keeping tabs on your finances simple. The app integrates with a range of other business tools to make business booking easy.