Is Your Gross Margin As Big As Your Smile?


“A business doesn’t run on sales volume or sales $$, it runs on gross margin”
In order to survive, your business has to have sufficient gross profit. Simply, gross margin is the money the business retains after incurring the direct costs associated with producing the goods and services sold (Cost of Goods Sold). The bigger the left over, the more money your business will have to cover other fixed and operating costs and most importantly to make a profit.  As you have realized, it is a pretty simple concept but businesses often ignore the importance of having healthy profit margin.
Cost of Goods Sold is the accumulation of all the variable and fixed costs directly related to your sales and excludes costs such as marketing expenses, rent, office expenses,…
 
Now, you might ask yourself: “Why should I care? Isn’t it all about sales revenue or profit?!”
So, let’s explore the importance of knowing what your gross margin is.
You first need to calculate your gross margin simply by following below formula:



But gross margin is so much more than just a number:
- It gives you a sense of competitiveness
There are various benchmarks for gross margin percentage and it depends on your business or industry. For example, jewelry stores can reach up to 50% of gross margin and this can go to about %30 for restaurants.
So, do your best to establish a benchmark as it helps you identify where your business sits among its competitors within the industry.
- It indicates the management effectiveness in utilising labour and material in the production process
- It could drive or dictate product/service unit prices
For example, if a business is selling 1000 tea boxes each month and it is aiming for 40% ($10,000) gross margin, then the sales price for each unit should be set at $25.
Targeted Gross Margin
40%
$10,000
Cost of Goods Sold
60%
$15,000
Sales Revenue (*)
100%
$25,000
Number of Unit Sold

10,000
Unit Price

$25

(*) Sales revenue = 1000 (unit) * (unit price)
- Other operating expenses such as marketing costs, fixed rent, utilities,… would be manageable when you are able to predict how much money the business retains after goods or services are sold

To conclude, if gross margin is ignored, pricing can be based on the wrong assumptions, measuring effectiveness cannot be easily achieved, managing other operating expenses might be difficult to handle and that’s where the business might run into trouble.




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