As a business coach, I often sit down with new clients and discuss their financial reports, and the first number I look at is their gross profit margin, the key financial indicator most owners overlook.
Most can give me the basics about their finances, but nine out of ten business owners look a little lost when I ask them about their gross profit margin.
So let’s first begin by looking at what Gross Profit Margin is.
Gross Profit = “Total Sales” less “Cost of Goods Sold”
Your “Cost of Goods Sold” is your direct cost to produce or acquire to resell your product or service.
It generally includes materials cost and direct labour costs.
When you express your Gross Profit as a percentage of your total revenue, then you get your “Gross Profit Margin”.
For example, if you were a business with 1 million in sales – that’s your total revenue – and a Cost of Goods Sold of 250,000, then your gross profit margin would be 75%
750,000 gross profit divided by 1 million in total revenue.
In a very important way, your Gross Profit Margin is a simple measure of your ability to be profitable.
If it is too low, what that is saying is that your price relative to the cost of producing your product or service is simply too low for you to ever be profitable.
In this video I look at how to use Gross Profit Margin in your business.
Once you know this key financial indicator, you can start asking better questions about your pricing and your costs. If you want to go deeper, have a look at our guide on what profit margin means for business owners, or read the definition of gross margin for the formal accounting view. And if your margin is lower than you expected, that is exactly the sort of thing a good business coach can help you fix.
