Gross Profit Margin: Why It Matters

Gross Profit Margin is the money your business is making for a product or service you are selling. So, an essential concept to track to make sure your business is profitable.

What is Gross Profit?

Gross profit is the difference between your sales price & the costs necessary to sell your good or services. Or the amount of money that your business has left over after accounting for the costs of producing your products or services.

How to Calculate Gross Profit

To calculate gross profit, simply subtract Cost Of Goods Sold (COGS) from sales. For example, using simple numbers, if your company’s sales last month where £10,000 & it spent £8,000 on COGS, the gross profit is £2,000.

How to Calculate Gross Profit Margin

Gross profit margin is a % measure of profitability that shows how much money your business keeps after accounting for COGS, expressed as a percentage of sales. To calculate it, divide gross profit by sales.

Using the example above:

£2,000/£10,000 x 100 = 20%

So, the gross profit margin is 20%.

Why is Gross Profit Margin Important?

Gross profit margin percentage of sales your company is making after deducting the costs of production. It’s important to track this over time & against industry average, because it is a good indicator of the profitability of your business. It is a crucial number know & use in budgeting & forecasting.

Knowing what it is for each of your product or service helps you to understand why your numbers might be changing. For example, fluctuations could highlight where you need to take action. For example, a big increase in a component(s) might mean you need to find an alternative source, increase your price, increase efficiency or discontinue that product to stay profitable.

Comparing Gross Profit Year-on-Year

It is important to track gross profit margin over time, this helps you to see if your business is becoming more or less profitable. To do this, calculate the gross profit margin for each year or ideally each month & track the trend.

Declining gross profit margins, is a sign that your business might be in trouble, because this is caused by increasing costs or declining sales revenue. You must investigate any changes in gross profit margin so you can take steps to sustain or improve your business’s bottom line.

Conclusion

Gross profit margin is a crucial metric, because it is the financial basis on which your business operates, or the cash the business is generating. It’s an important measure to monitor & understand. Not knowing how much profit you are or can make not a good place to be.

You need to why & how it changes, along with how it compares to your sector average, so you know how to improve your bottom line to stay in control of your finances. It is also a number investors, lenders or someone wanting to buy your business will want to see.

Gross Profit Margin: Why It Matters