In order to know if your business is effective, you’ll need to measure profitability. To do this you should measure gross profit and gross profit margins. Generally, the higher your gross profit and gross profit margins, the healthier your business is so it’s a key factor in determining and managing your business’ effectiveness.
What is gross margin?
A gross profit margin is the difference between sales and the cost of goods sold divided by revenue. This represents the percentage of each pound of a company’s revenue available after accounting for cost of goods sold.
How can a business calculate gross margin?
The formula to calculate gross margin as a percentage is:
Gross Margin = (Total Revenue – Cost of Goods Sold)/Total Revenue x 100.
The gross profit margin shows the income your business has left over after paying off all direct expenses related to the product or services.
Gross Profit Margin = (£5,000 – $2,000) / $5,000 = 60%
The above formula tells you that your company has 60% of its revenues (gross profit) left over after it pays the direct costs associated with its products or services.
Gross margin is the calculation of how much it costs your business to get your product or service in to the customer’s hands taking away the cost of the goods or service. You should include the cost of shipping to you (for hard goods) and the general running costs of your business (utility bills etc.)
It is important to keep in mind however, that the calculations you use to determine your business gross margin will be different from industry to industry and also vary depending on your company goal. Whether you are selling a product or service will also have an impact.
How to improve profit margin
To help improve your profit margin, ideally you need to cut costs. For example, if you sell a product for £1000 and the cost of the producing the phone is £500, the current gross profit margin is 50% ((1000-500)/1000). If you can reduce production costs from £500 to £400, the gross profit margin is 60%.
Gross profit margins will vary from industry to industry and business to business. However, if you need to increase your gross profit margin you essentially gave two options: Increase your prices, or reduce your costs.
In an ideal world you would simply increase your prices and make more money. But you have to be careful not to price yourself out of the market. Make sure you take a look at your competitors offerings before you make a decision. If you’re selling the same product at a higher price customers are unlikely to purchase from you over a competitor selling at a lower price.
Take a look at the below example:
To purchase stock costs you £100 and you sell it for £120. This gives you a gross profit of £20 and a gross profit margin of approximately 17%. You need to increase your profit margin so in turn, you increase your prices.
You purchase stock at £100 then attempt to sell it at an increased price of £150. If you are successful and the stock sells, you will improve your gross profit margin to an impressive 50%. However, by increasing the price you risk not selling the stock at all, which could leave you with negative gross profit.
That’s why competitor analysis is an essential part of the process.
Reducing costs can be difficult because if you thought you could reduce your outgoings you would already be doing it right? However, it’s still worth taking a look at possible areas of your business where you might be able to pull in the ropes. The best scenario would be to ask your supplier for a reduced rate and they agree.
For example: If you reduce your stock purchase price from £100 to £70 your profit margin increases to approximately 70%. In a perfect world you’ll be able to leverage from both sides and increase your prices while also reducing your outgoings.
Why do you need to know your profit margin by product / service?
By knowing the gross margin on all the products or services you offer you can accurately price them within your market. You need to make sure your pricing reflects the cost of purchasing. Accurately determining what your product or service is going to cost to be ready for sale is essential to the success of your business.
One thing you must remember is that gross margins change. This can be a result of increased or reduced costs or due to increased or decreased inefficiencies within your business. It’s paramount that you remain aware of your profit margins in order to assess the effectiveness of your company.
AIM Internet can help grow your business
Gross profit and gross profit margins are an important evaluation technique for your business, if you think there might be room for improvement in your business but don’t know where to start then speak with one of our experts from our digital marketing agency Birmingham. Call us today on 0870 062 8760 or send us an email at firstname.lastname@example.org to see how we can help increase your business’s gross margin.