Knowing your gross profit is one of the most important steps to understanding the health of your business. Gross profit is the amount of money a company makes after subtracting the cost of goods sold from total revenue.
In this blog, we are going to look at what gross profit means for your business. Your business journey map must have profit as a destination point. When you set your numbers dial to profit, you’ll be looking at gross and net profit.
In the world of numbers, gross does not mean unpleasant or disgusting – though making a rubbish gross profit is not good.
What does gross profit mean for your business?
Firstly, let us take a closer look at what we are talking about. And the best way to go about it is to illustrate using an example.
So, let’s imagine that Govan sells second-hand trainers online at £100 per pair. Now, if he sells twenty of those, he makes £2,000 in sales. Congrats to Govan, but that’s not his profit. He needs to buy and clean those trainers before selling them. The costs are £40 a pair. This means that Govan makes £60 profit for each pair he sells, a total of £1,200. That £40 is his gross profit.
What is gross profit?
Your business may be in the hospitality business selling food. The difference between the cost of making a meal and selling it is gross profit. If your business sells training courses, the difference between course fees and venue hire and materials is gross profit. Where your business makes things, the product selling price minus the cost of making it is the gross profit.
For the record, gross profit (GP) is also called gross margin. The costs of buying trainers, food, room hire materials is the cost of sales.
Check out our FREE online profit and pricing calculator.
Why is gross profit a big deal?
Firstly, your business’s gross profit is one of the most important financial barometers for the health of your business. Every time you sell something then your bucket of money builds up. Out of this bucket, you need to pay for all your business expenses, including paying yourself. These costs are typically fixed expenses. Once you cover your fixed costs, you’re left with net profit.
Secondly, gross profit assesses how efficient your business is in using your staff team, materials and manufacturing set to make and sell what you do. Therefore, it is a metric that mostly is concerned with variable costs. These costs fluctuate in response to your business activities. materials, wages, sales commissions, credit card fees, and shipping.
Making Decisions in your Business
Thirdly, knowing and understanding your gross profit helps you make fantastic business decisions. What sort of decisions, you might wonder. This metric is essential for making informed decisions about pricing, customer relationships, and product selection. Pricing strategies, decisions on outsourcing, dropping products, evaluating business opportunities, and sacking clients, are just a few examples of the application of gross and net profit.
For example, let’s say you want to expand your market share. Knowing what you can play around with (discounting and bundle packages) is easier when you know what your gross profit is.
Profit margin and pricing
Most of us want to sell more, and make more profit. Who wouldn’t? One way of doing that is knowing what your costs, markups and margins are.
This FREE profit calculator shows you what gross profit you are making now. But what if you altered your selling price and costs? Type in your numbers to our calculator. See what the numbers show for your business.
Good GP gives you much healthier cash flows. Gross profit has a direct relationship with selling prices. The higher the margin, the better your business has been making revenue.
How to measure and manage your GP?
Measuring is half the battle, managing is the other half. To go back to our earlier example with Govan. He wants to make more profit from selling trainers. There’s a number of things he can do. He can charge more than £100 per pair of trainers. Govan can also spend less on buying the trainers.
It is easier (not easy) to control and manage cost of sales, such as training shoes, food, materials. It is less easy to control support costs like insurance, salaries and wages, and business rent.
Ultimately, a good gross profit margin might well rely on the industry but that said, you want your gross profit percentage to be one that allows you to both cover your costs and give you a competitive and healthy return for your business.
When you know your GP, you can determine your break-even point. This is the point at which your business covers all of its costs and the squeaky bum stops. Knowing your break-even point can help you understand how much of a cushion you have for discounts, bundle packages, and penetration pricing. It can also help you decide which customers and products are best for your business.
Having a good GP can help you improve your cash flow. Once you know your gross profit, you can use it to make smart decisions and ensure that your business remains healthy. So, if you want your business to carry on, sustain, survive then learn to keep an eye on your gross profit. If you don’t do this then you are missing a trick, and your business can suffer and lose money.
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