By the end of this blog post, my goal is to make you a master of your gross margin. You'll know what it is, why it's one of the most important numbers in your business and how to calculate it.
Here's a quick 60-second video on how to calculate gross margin:
True, this information will make you look smarter in front of investors, lenders and business partners. But more importantly, you'll have a healthier business that is more profitable.
This is good stuff. If you're a business owner, let's jump in and get started.
First the Definition
Gross margin is a percentage that you can calculate by looking at your income statement. This percentage tells you how much money you get to keep from your sales after you pay for the costs you incurred to make your product or provide your service.
When you calculate this percentage, you'll need to know a few things beforehand:
- A list of all the products or services you sell
- The price for 1 unit of each product or service
- The total costs you incur to create 1 unit of product or provide 1 unit of service
How to Calculate Gross Margin
Let's break this down. Pretend that your company sells two types of products: blender bottles and beard oil. Maybe you cater to athletic lumberjacks. Who knows?
When business owners get stuck on gross margin it's usually because they sell more than one product, each with it's own cost structure and price point.
In this example we have to products to help you see how to make this work.
Notice that the above spreadsheet leads you to a number called "gross profit." This is not your gross margin. Stated in dollars, gross profit tells you how much money you get to keep after covering the costs of the product or service you sold.
In accounting, you generally want to get away from dollar figures and think with percentages when you are making analytical decisions about your company. The reason is that percentages allow you to compare your performe periods to each other more accurately.
Hence, gross margin was born!
The final step to calculating gross margin
All you need to do now is divide your gross profit of $222,500 by your sales of $250,000 for a percentage of 89%
Ta-da! Your gross margin is 89%
If you're looking for help on tracking your sales and costs more accurately, don't forget to check out our blog post titled: How Profitable Companies Track Revenue.
What Does This Mean?
This means that for every $1 that you make selling your product, you get to keep .89 cents to run your business.
Your goal as a business owner is to track this figure each month, work with vendors to get better deals on your costs and drive this percentage higher.
If I were your profit coach, I would set a goal to move this to say 90% within the first quarter.
What Can You Do with Gross Margin?
Once you know how to calculate gross margin, you can discover your break-even points, give departments goals for saving on specific costs and more. It really is one of the most important numbers in your business. Master this one and you're well on your way to running a lean business that can not only make payroll each month, but grow.
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