A Quick Refresher on Gross Profit Margin
It’s difficult for a small business owner to know where they are going if they don’t have a full understanding of where they have been. That’s why accountants and financial analysts play such an important role in helping small business owners guide their business into . There’s a lot of ways for business owners to measure the way their businesses are performing. Each line item on a financial statement has a very specific meaning. It tells a story about some aspect of the business and how it operates. To enhance the meaning of numbers, financial professionals have developed several meaningful calculations in the form of what they refer to as ratios. These ratios provide a fast and easy way for business owners, banks, and government regulators to see how a particular business has been performing. As you contemplate where your business stands today, we thought it would be useful to provide you with a reminder of how to calculate and use one very important ration called . Your offers you and others insight into how effectively and efficiently your business is performing. In the sections below, we would like to give you a quick refresher about the concept of . We hope you will find this information useful as you make key business decisions in the future.
Understanding
Before you can learn how to calculate a , you need to first understand the meaning of . As a business owner operates their business, they sell goods or provide services. In the process of doing so, they bring in and incur certain expenses, often referred to as “ of goods sold” or “ of services rendered.” is calculated as follows: – of goods sold = To simplify the following explanation, we want to focus on a business that sells sneakers. Here is an example that will hopefully paint a proper picture of how to calculate your : Company A sold 100 pairs of sneakers at $20 a pair. The of manufacturing those 100 pairs of sneakers was $10 per pair. Let’s calculate the : $2,000 () – $1,000 ( of goods sold) = $1,000 () If this were a stable business, the business owner could rightfully expect to make a of $1,000 for every 100 pairs of sneakers their company sells. That information is important because it gives the business owner a sense of direction. Before we move forward to discuss a rate or , we want to explain the of goods sold in more depth. The of goods sold is comprised of two types of expenses, variable and fixed. Variable expenses are incremental amounts a company will incur with each unit they manufacture or purchase. Typical variable costs include shipping costs, manufacturing materials, and (factory laborers, commissions to salespeople). Fixed expenses are expenses the company expects to incur no matter how many units they manufacture or sell. The most common fixed costs will generally include office salaries with payroll taxes and benefits, facility rent, property taxes, utilities, office supplies, and insurance. All of these expenses combined make up the of goods sold. The only business expenses not included in this number would be things like business taxes, amortization, and asset depreciation.
How to Calculate the Rate
Once you know your , you can determine your . By converting the to a , you will be better able to make useful industry comparisons to see how your company is performing against the competition. The is calculated as follows: – of goods sold () / = . Using the same information from the aforementioned example, here’s Company A’s : $2,000 () – $1,000 ( of goods sold) / $2,000 () = .50 or 50%.
Practical Uses for the
The importance of your will depend on your willingness to use it to make important business decisions. You might be asking yourself, “what is a good ?” Well, that depends on the industry in which your company is competing. If you sell sneakers, your competition might be major footwear manufactures like Converse and Nike. If the normal within your industry is 75%, a 50% would not be healthy. Conversely, a 50% in the sunglasses industry might be quite healthy if other companies within the industry are operating with margins around 40%. As a good business operator, you should be using such ratios to help you make business decisions. Let’s take a look at some practical applications of the . We’ll stick with the same example. Let’s say you manufacture and sell sneakers at a 50% . The industry standard is 75%, and you would like to benefit from having the same kind of . There are two things you can do to increase your . The easier option would be to increase your prices. If you are selling quality sneakers below-market prices, you should have some room to increase your prices and bring in more without losing market share. That would effectively increase your . Of course, you are competing for customers. The marketplace will restrict your ability to increase your selling prices if the quality of your company’s sneakers is not comparable to the competition. In that case, you might want to consider lowing your costs related to producing and selling your sneakers. Even the slightest savings will serve to increase your to some extent. How would you go about lowering your company’s costs? You might start by negotiating better contracts with your vendors and suppliers. If that’s not possible, you might have to consider lowering your company’s fixed costs by as much as possible. If neither of the above options is possible, you might resort to a small price increase to be complemented with a slight lowering of expenses. The point is you will want to use your to help you decide how to move your business forward in the future. At first, it can be intimidating to look closely at your financial data in a meaningful way. If it’s not something that comes naturally to you, we can help educate you. Over time, you will find that using ratios to make important business decisions will become second nature to you. When you hit that point, you will have earned a “degree” in business management 101.
FAQ
What is the difference between and ?
Many people are initially confused into believing that the and are the same, but there is an significant difference between them. is what we calculate to know if the business is profitable. It is to know if the of the product or service sold covers what it to manufacture the same product, i.e. the of production. Nevertheless, the is different because it is the of the ; we use the formula of the dividing the result by the sales, in order to know the exact . These data must always be taken into account, even if we do not use them in the formula of this operation. They are mattering, such as , the , , indirect , , , , or . Calculating what we want will allow us to find out if the company has the , we are looking for and if it exceeds or stays away from the industry , where the company is located.
Automatically calculate your percentages?
For any business manager to calculate the or is not a difficult task, as they are supposed to have the exact knowledge to calculate them. However, some applications and websites make this job easier in order to save more time. Websites or Excel, you only need to enter the necessary data that the formula asks for to automatically calculate the . On the Internet, you will find a , and there are many ones to choose from, but most of them work the same anyway. Finally, as a recommendation, it is important to know how to get the even if you use an application that takes everything out automatically, knowing the formulas and why they are important and vital for the life of an entrepreneur. There are similar formulas but they do not end up being the same as the , the and the .
What does it mean when operating as a percent of increases each year?
It means that your company has not only increased sales but also that there have been fewer expenses that affect your business. It is good news to know that the of operating has gone up, it means that the company is on a good track, is well-positioned and there is a good . However, it does not mean that calculating this will answer all the questions. For instance, by means of this , we are not seeing the exact of the company and not knowing this would put the company at risk, since we would rely on data that helps but is not enough. If you really want to know if your company is being more profitable you have to take out more operations like the .
How do you calculate in dollars?
It is basically the same to calculate it in dollars, you just have to subtract the with the of the goods sold, but without forgetting that they are direct costs, i.e. and staff . Returning to the calculation, you have to do everything based on the dollar numbers and the result will be the in dollars. Now if you want to convert it into a you simply do the same but add divide the total and then multiply it by 100. The whether it is in dollars or in , you need to take it out and more for the financial analysts and accountants to make recommendations based on the results, also it would not hurt to take out and margin of contribution.