Have you ever wondered where the \u201cbottom line\u201d on profitability starts? \u00a0It actually doesn\u2019t start at the bottom. \u00a0The \u201cbottom line\u201d starts up higher on the income statement with a healthy Gross Margin (GM) or Gross Profit Margin. \u00a0Simply stated, GM is total sales revenue minus the cost of goods (services) sold, divided by the total sales revenue (expressed as a percentage).<\/p>\n
(Revenue – Cost of Goods Sold (or GP)) \/ Revenue = Gross Profit %<\/p>\n
It is a critical measure in any business. \u00a0A healthy GM is the result of good decision making about the price and cost of your products or services. \u00a0GM represents a key factor behind many of the most fundamental business considerations, including break-even sales, budgets, and forecasts. \u00a0These decisions are significant for becoming and staying profitable.<\/p>\n
So, what is the definition of \u201chealthy\u201d when it comes to GM? \u00a0As a starting point, GM must be sufficient to cover all operating expenses such as selling, marketing, distribution, warehousing and administrative costs. \u00a0GM must also adequately allow the business to realize the desired amount of net income or \u201cbottom line\u201d profit. \u00a0If both are true, then GM is healthy.<\/p>\n
GM percentages can vary widely depending on the industry served. \u00a0In the distribution industry, 30% GM can be attractive. \u00a0In manufacturing, there is often more internal control over costs, and margins above 40% to 50% are a reasonable goal. \u00a0Service firms adding real value to client companies can also enjoy a high GM. \u00a0No matter the industry, it\u2019s important to know the industry average and seek to be at or above it. \u00a0If the business has below industry average GM then their value equation is likely out of balance.<\/p>\n
So what can be done to increase GM? \u00a0Many levers exist to make this happen. \u00a0The most obvious ones are increasing prices and reducing costs. \u00a0Less obvious are managing the mix of products or services you sell to customers, taking advantage of early pay discounts if cash flow is sufficient, negotiating volume discounts, asking for volume rebates or other trade rebates on purchases, and periodically introducing profitable new products or services.<\/p>\n
Many times uncovering opportunities to increase GM requires more in depth data mining and analysis. \u00a0For example, a review of all items being sold at an average price generating less than breakeven GM is necessary. \u00a0This analysis can reveal opportunities with certain customers or even help decide to exit or deemphasize unprofitable lines of business.<\/p>\n
One real-life experience involved a retail establishment that used an inventory software system in addition to QuickBooks for their accounting software.\u00a0 Over time the actual inventory markup per items in the inventory system produced erroneous retail sales prices.\u00a0 As a result, actual GM averaged 10% lower than their expected margins (26.32% versus 36.86%).\u00a0 This error resulted in a \u201cbottom line\u201d loss of $400,000 on annual sales of $4,000,000.<\/p>\n
As a B2B CFO\u00ae<\/sup><\/b>, helping clients improve GM is a role I play frequently and one that I enjoy. \u00a0Having a healthy GM enables company leaders to focus on growing, not simply surviving. \u00a0Even though one specific fix does not fit all companies, one or more of the possible actions discussed above can make an immediate impact on GM. \u00a0If you would like to make sure that your business is at or above your industry average in GM and clear the path to reaching your targeted bottom line profit, please contact me.<\/p>\n photo credit: Start Starting Line Americorps Cinema Service Night Wilcox Park May 20, 20118<\/a> via photopin<\/a> (license)<\/a><\/p>\n","protected":false},"excerpt":{"rendered":" Have you ever wondered where the \u201cbottom line\u201d on profitability starts? \u00a0It actually doesn\u2019t start at the bottom. \u00a0The \u201cbottom line\u201d starts up higher on the income statement with a healthy Gross Margin (GM) or Gross Profit Margin. \u00a0Simply stated, GM is total sales revenue minus the cost of goods (services) sold, divided by the…<\/p>\n","protected":false},"author":45,"featured_media":3854,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"_editorskit_title_hidden":false,"_editorskit_reading_time":0,"_editorskit_is_block_options_detached":false,"_editorskit_block_options_position":"{}","cybocfi_hide_featured_image":"","footnotes":""},"categories":[19,23,21],"tags":[18,22,20],"class_list":["post-3853","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-business-best-practices","category-cash","category-exit-strategies","tag-business-tips","tag-cash-flow","tag-exit-strategy"],"acf":[],"yoast_head":"\n