Managing profit margins when you own a business is crucial to success. It aids you in making decisions that improve the company and lets you adapt to client needs more quickly. You become a leader that is proactive and makes decisions based on facts.
A lot of information about profit refers to net profit. Net profit is the difference between all expenses and revenue. In some industries, knowing gross profit is more pertinent. Either way, knowing the difference is essential.
What Is Gross Profit?
Gross profit is the amount of revenue after removing the cost of the goods. The amount subtracted is sometimes called COGS or the cost of goods sold. Gross profit is sometimes called gross income.
Calculations use no other expenses to determine gross profit. Only the actual cost of the goods or service is used. For example, if you sell 100 widgets at a roadside stand for $10 each, you will receive a total of $1,000. If it cost you $5 each to get the widgets, you paid $500. $1,000 - $500 = $500. Your gross profit is $500.
Gross Profit vs. Net Profit
Both types of profit subtract the cost of the actual product. Net profit removes operation costs, including salaries, rent or lease, utilities, and taxes. Net profit is a more precise assessment of company increase. Gross profit is often a suitable calculation.
To continue the example above, suppose you pay someone to man the booth $10 an hour. Also, suppose you rent the booth for $20 a day. If it takes an 8-hour day to sell 100 widgets, subtract $80 for salary and $20 for rent. Your net profit is $400.
Gross Profit Formula in Balance Sheet
The basic gross profit formula is:
Total revenue - the cost of goods sold = gross profit
You can add this to a separate line in your balance sheet. Compile the revenue and costs separately, then subtract.
Gross Profit Formula Excel
If you are working on Microsoft Excel, follow these steps to insert the formulas and get your results.
- Add product costs
- Add total revenue
- Subtract costs from revenue
The formula looks like this:
Replace TR with the address of the cell containing the total revenue, such as B2. Replace PC with the address of the cell containing the product costs, such as C2.
How to Calculate Total Gross Profit
The first step in calculating total gross profit is to add up total revenue. Add together all sales and earnings from products or services for the chosen time frame.
Next, determine your cost for creating the good or service. The cost includes such things as ingredients or parts, wholesale costs, and supplies.
Subtract the costs from the revenue. The result is your gross profit. How to calculate gross profit from balance sheets is the formula above.
What Is Your Gross Profit Margin?
A company's gross profit margin is a metric analysis of sales. It is the gross profit percentage of total sales after the cost of goods sold but before other expenses.
Companies that calculate their gross profit margin regularly see patterns. If the numbers fluctuate wildly, the company should investigate to determine why. There may be a problem with the product or with the management. When a company has made major changes, it can expect fluctuations.
The average gross profit margin in retail businesses worldwide is about 52%.
How to Calculate Gross Profit Margin
The formula for gross profit margin is:
Gross profit / total revenue = gross profit margin
When you divide the gross profit by the total revenue, it provides a decimal. Convert this to a percentage and that is the gross profit margin. The larger the percentage, the more efficient the business.
Tips to Increase Gross Profit
There are many ways in which you can boost your gross profit.
Price and Value
Add value in effective ways to raise prices. For ideas on what to add, ask clients. Those who buy from you will have ideas to offer.
Change things so price competition is unnecessary. Make it so people want to buy from your company. Stand above the others. Price is not the only thing to consider in a product. Improve brand value.
Alter your focus. Expand the scope of the company. If the product or service has less common uses, promote them along with the usual information.
Automate what you can. Especially when the business offers a service, automation can cut costs.
Avoid markdowns. Manage inventory and make sure people can see what is available. Control purchases to limit excess. Reduce delivery costs, if possible.
Cross-sell and upsell to increase average order value. Current customers are already purchasing from you and are more likely to be willing to add more. A section with add-ons or "people also buy" will encourage larger purchases.
Recognize where waste occurs in the process and find ways to drop the excess. Don't build up too much inventory.
Don't just cut prices. Make offers personalized. Some customers will buy at a smaller discount than others.
Encourage efficiency and improved production from your staff. Set goals, train your team, and develop good characteristics in your employees. Streamline operations to reduce expenses.
Negotiate with your vendors. Landing a discount on what you use to create the product or service will increase the margin. Improve relationships with them. Adjusting costs and making the process more efficient will help both of you.
Promote the products that bring in a higher margin. Then if someone is uncomfortable with it, offer the lower profit alternatives.
Use methods to cost-effectively promote products and services. Possibilities include the internet and social media.
Try a tiered pricing system. Offer a basic and a premium. Many consumers prefer a premium version.
The gross profit formula of revenue minus cost of goods sums up a company's financial health. Remember that costs like buying the product and directly related costs are subtracted. Costs like loan payments, rent, and taxes are not.
About the Author, James Webster
James Webster, founder and Executive Chairman of ROK Financial has almost two decades of experience within the financial services industry. His passion for helping small business owners and his innovative way of thinking, has allowed him to run multiple successful businesses including National Business Capital & Services. Under the National name, the team was able to help secure over $1 Billion in financing for small businesses nationwide.