Back to Basics: Gross Profit & Gross Profit Margin
When you’re analyzing your company’s financial health, it’s essential to pay attention to your gross profit and gross profit margin.
Your gross profit indicates how much money your company makes after deducting the costs associated with creating your products or providing your services.
To determine your gross profit, you need your sales numbers and cost of goods sold (COGS). Your COGS are the costs directly related to purchasing products for resale or manufacturing products to market.
Variable costs vs. fixed costs
Variable costs change based on the amount of product you’re producing – they’re incurred as a direct result of creating your products or providing your services. They include:
- materials used
- direct labor
- plant or warehouse utilities
Fixed costs, on the other hand, don’t change based on how much you produce. Fixed costs are operating expenses and aren’t generally included in your COGS. They include:
- office supplies
- salaries and wages of your office staff or salespeople
- payroll taxes
- employee benefits
- advertising expenses
Read also: Direct vs. Indirect Expenses – What’s the Difference?
Calculating Gross Profit
For example, if your sales were $20,000, and your COGS were $15,000, your gross profit is $5,000.
Gross Profit Margin
Your gross profit margin expresses your profits as a percentage of your sales.
For example, if your gross profit is $5,000, and your sales were $20,000, your gross profit margin is 25 percent.
Improving Your Gross Profit Margin
Without an adequate gross profit margin, it can be difficult for your company to pay its operating expenses. To improve your gross profit margin, you can increase your prices or decrease your COGS.
Before you decide to increase your prices, pay attention to your competitors’ rates and the demand for your product. If you price your products too high, you might lose sales. Read also: How Much Should I Charge?
You can also decrease your COGS by manufacturing your products more efficiently. Work with your suppliers to get volume discounts for buying materials in bulk. If your suppliers won’t give you a discount, consider finding a cheaper supplier.
Your markup is related to your gross profit margin. Instead of being a percentage of sales, however, it’s a percentage of costs.
For example, if you sell your product for $20 and spent $15 to produce one product, your markup is 33%.