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Gross profit margin is your key to understanding profitability

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As I mentioned in my post last month, gross margin is one of the key metrics to looking at profitability on your P&L. Simply put, gross margin = net revenue less COGS (Cost of Goods, or Services Sold). For example, if your revenue is $100K and total COGS are $30K, your gross margin is $70K. In that case, your gross margin ratio is 70%. For each dollar of revenue, your company earns 70c in profit. That profit means you can pay for other costs such as selling, general and administrative expenses.

A gross profit margin metric is independent of your sales volume: if revenue doubles but COGS stays the same on average, your gross profit margin will also stay the same.

You can use your gross profit margin in a number of different ways. Look at gross profit margin on a trend line over the prior 12 months. Compare your current status to where you were at the same month last year, and see fluctuations that may arise due to seasonability, revenue growth, decline that outpaces COGS, or COGS expenses increasing while revenue stays steady.

Identifying the cause of a deviation from your average gross margin number helps with planning and forecasting. A poor trend line is fixable! See it as an opportunity to conduct an in-depth analysis and plan for improvements.

Another measure worthy of analysis is comparing your trend line to industry averages, or the results of a public company within your industry that is similar to yours. (You can find financial statements for public companies online at SEC.gov.) Your CPA may be able to provide some benchmark information as well. If reviewing your gross margin trend line produces more questions, you can dive deeper with additional analysis (depending on how your QBO file is set up).

Break down gross profit by product or service at a direct cost level to see which factors create the impact. The results may signal it’s time to increase prices, revamp a service or product, or remove an item altogether.

You can also do a deep dive and analyze gross profit by customer. Look at direct cost levels. Do you you put more time and money into seasonal or less frequent clients? This may indicate it’s time to pivot to a different client base.

If you have questions about your gross profit margin or are curious about what an in-depth analysis can tell you about your profitability, your CSM is here to assist with this or any question you have related to your financials. In-depth analysis can lead to better planning and assist in knowing what changes to make, and ultimately increased profitability.

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