Gross Profit Maximization - Jun 8, 2010

Posted by: David Kirkup in Articles

One key aspect to building value in a company is that of optimizing gross profit. Gross profit  is what you have left after the direct costs of the sale of a product or service, such as materials and direct labor, are paid for. It is expressed as a ratio of sales and should be as high as possible depending on the industry - certainly above 50% and sometimes as high as 90% in service companies. 

Gross Profit is a key metric for every business to manage, as it impacts both how fast your company breaks even and the amount of profit that can be earned once that happens. Every business has overhead costs such as rent, office, payroll that are relatively fixed and these have to covered before you can become profitable.  In other words, gross profit directly impacts risk and return. The levels of gross profit margin can vary drastically from one industry to another depending on the business. For example, software companies - which are selling services - will generally have a much higher gross profit margin than manufacturing companies - which may have significant labor, inventory and overhead costs built in to the cost of their product.

To illustrate how gross profit margin affects break even and profit, consider a company with $300,000 in fixed overhead expenses. If the firm's gross profit margin is 50%, it would need to generate sales of $600,000 to cover overhead. If we were able to increase gross profit margin by 2 points to 52% instead, break even would decrease by $23,000 or approximately 4%. The company would then start earning a higher profit of $0.52 on each dollar in sales after revenues reach $577,000, rather than just $0.50 on the dollar after $600,000.

Inadequate gross profit indicates problems with prices that are too low and/ or direct costs that are too high, and therefore problems with break even and profit. When a company is generating adequate sales but gross profit margins are low, it signals an issue in one or both of these areas. This lack of understanding often leads to decisions that only worsen the company's position, such as attempting to increase sales via lower prices, leading to even smaller gross profit margins - so-called "making it up on the volume"

Gross profit optimization often does not get the attention it deserves. Companies should be aware of the factors that will impact gross profit margins and pay close attention to them.

A B2B CFO advisor can help companies find a benchmark for gross profit margin using competitor data and industry averages to provide a targeted goal. They can also help measure and manage the factors impacting gross profit margins as they change over time. A B2B CFO can help analyze gross profit by product or service, and highlight low margin products, or help restructure service delivery to optimize gross profit.

Call David Kirkup, Partner at B2B CFO, for a complimentary "Executive Company Physical" and a plan for how to get where you need to be at 404 348 0326 or dkirkup@b2bcfo.com.

(877) 4-B2BCFO

info@b2bcfo.com

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