Understanding Gross Profit Margin

In business, there are several ratios that allow us to better understand our business, but few are as essential as gross profit margin. Not only is it relatively easy to calculate, but it is vital data for making informed decisions and comparing yourself to your competitors.

Distinguish the different margins

Gross profit margin is the money left over after the sale of a product or service. In other words, if you sell a good for $10 and it costs you $5 to produce it (after deducting materials, human resources, distribution, etc.), your gross profit margin is $5. , or 50%. Attention, to arrive at this value, it is necessary to subtract from the income that the direct costs with the production. This calculation does not include administration, selling costs and fixed costs. When we subtract these expenses from the gross margin, that gives us the operating profit. Once all the other costs and taxes have been paid, we will talk about the net profit margin.

In summary:

Gross profit margin = ((revenue from sale – direct costs of sale) / revenue from sale) x 100%

Operating profit = ((gross margin – fixed, selling and administrative expenses) / gross margin) x 100%

Net profit margin = ((operating profit – other fees and taxes) / sales revenue) x 100%

What is gross profit margin used for?

Since it is not always obvious to allocate one’s share of fixed costs and administrative costs to each product sold, operating profit and net profit margin are more useful to get an overview of profitability. of the company. In return, the gross profit margin gives you the opportunity to refine your day-to-day tactics.

You can first compare yourself to your competitors. Sectors do not all have the same reality regarding this ratio. For example, in Canada in 2020, grocery stores had an average gross profit margin of 24.5% while that of the retail trade was at 35% and that of the construction industry at 42.6%. These statistics are available on the Canadian government website .

If your margin is lower, then you are lagging behind your sector. On the other hand, if you are above average, it gives you options to increase your advantage, such as lowering your prices to take a bigger share of the market or getting discovered by new customers.

A comfortable profit margin also allows you to cushion the shock of a surge in raw material or wage costs and not immediately pass the bill on to the consumer.

Finally, you will be able to identify and focus on high-margin products while abandoning those that, despite your efforts, do not pay off.

How to improve your profit ratio?

You will now have understood that grabbing new percentage points from this margin is one of the sinews of war. There are different strategies you can use to grow it.

1) Improve your efficiency
Your margin may be weighed down by direct costs that are too high. Perhaps you are able to buy your raw materials in bulk to reduce their price or even obtain equipment that allows you to reduce the burden of wages. You will also want to pay particular attention to losses and waste. Find ways to eliminate them as much as possible.

2) Increase your value in the eyes of your customers
On the other side of the spectrum, you can also raise your prices. However, this can be risky in a competitive market. You could, on the other hand, add functionalities to your product or service, use materials perceived as more luxurious, redesign the lines of your merchandise to make it more attractive and justify this increase without blowing up your production costs.

Ultimately, this simple gross profit margin ratio can really help you refine your business strategies. Follow this number consistently, so you can see the blows coming and make the most of certain opportune circumstances.

Eleanore Frinqois

Eleanore Frinqois, Lead Editor at BusinessGrowthCoaching.co.uk is a business leader with over 30 years in both start-up and enterprise level organisations. Previously Operations Directer at a £1.8BN media group, alongside setting-up and later selling 3 digital brands - Eleanore has expertise across all aspects of business growth.

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