Why Should A Business Owner Understand Their Gross Margin? - Paul C. Morin - Ask A Business Expert

Why Should A Business Owner Understand Their Gross Margin?

All business owners know that they must make a profit to be successful.

But have you ever gotten to the end of a year only to find out that your business didn’t make a profit?

One of the main reasons that this happens is because business owners don’t understand the concept of gross margin.

What Is Gross Margin?

Gross Margin is equal to total revenue minus the total cost to produce products or services. By understanding what their gross margin is, business owners can gauge whether their business is making money or losing money. Once they know their gross margin, business owners can have honest discussions about key factors including reducing supply chain costs, improving operational efficiency, improving raw material sourcing and more.

If you’d like to read our full definition of what Gross Margin is, then check out the Ask A Business Expert Dictionary by clicking on this link.

If you’d like to watch a video featuring Business Expert Paul C. Morin explaining the concept of Gross Margin, then click the video below – or read on!

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How A Business Owner Can Take Advantage Of Their Gross Margin In 5 Steps

My name is Paul C. Morin and I’m an Accountant with over 25 years of experience, as well as being the Owner of Padgett Business Services Edmonton NW.

In this article I will help you understand what gross margin is, and give you 5 key steps to help you leverage the concept to grow your business!

The 5 steps include:

    1. Understanding Gross Margin
    2. The Gross Margin Profit Ratio Formula
    3. Where To Find Your Gross Margin
    4. Why You Should Track Your Gross Margin Every Month
    5. How To Get Help From Your Accountant

Click below to download your copy of the ’How A Business Owner Can Take Advantage Of Their Gross Margin In 5 Steps.’

How A Business Owner Can Take Advantage Of Their Gross Margin In 5 Steps

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Step 1: Understanding Gross Margin

For example, let’s say that you operate a retail clothing store. Your total revenue for the year is $300,000, and it cost you $100,000 to buy the clothing.

To calculate your gross margin, you would do this calculation.

Total Revenue                                 $300,000

– Total Clothing Costs                    $100,000

Gross Margin           =                      $200,000

Now that this store owner knows what their gross margin is, they can begin to talk about how it can be improved by discussing a wide variety of possibilities including:

  • Finding out if there are alternate suppliers who have lower wholesale prices for the clothing they want to acquire
  • Talking about how their clothing buyer is negotiating deals and figuring out if the buyer needs sales education to improve

Along with understanding Gross Margin it is also worthwhile for business owners to calculate their Gross Margin Profit Ratio.

“Look for companies with high profit margins.”

Step 2: Gross Margin Profit Ratio Formula

Here’s the formula:

Gross Margin Profit Ratio = Revenue – Cost Of Goods Sold / Revenue

Now let’s use the numbers from our example in Step 1 to do the calculation.

Clothing Store Gross Margin Profit Ratio = $300,000 – $100,000 / $300,000 = 67%

According to CSIMarket.com the average Gross Margin Profit Ratio in the retail apparel industry in the fourth quarter of 2020 was 59.13%

Armed with that type of knowledge our clothing store owner would know that their results were above average. This could compel them to figure out why they are overachieving, and hopefully get into a position to keep up the momentum!

Step 3: Where To Find Your Gross Margin

If you want to know your Gross Margin, then take a look at your Income Statement.

Gross Margin - Income Statement Image - Ask A Business Expert

Many business owners only look at their income statements once a year.

But if you’re not monitoring your Gross Margin on a regular basis, you could be losing a lot of profit within your business.

Step 4: Why You Should Track Your Gross Margin Every Month

Let’s go back to our clothing store example to see why regular monitoring is so important.

Let’s say that the total business revenue for the year was $300,000, but the accountant then informed the owner that the cost of clothing was actually $250,000 for the year!

Total Revenue                                 $300,000

– Total Clothing Costs                    $250,000

Gross Margin           =                      $  50,000

How will the clothing store owner be able to afford to buy clothing for next year? How will she pay herself and her employees? Will she have any money left to pay interest and taxes?

As an experienced accountant who has helped hundreds of businesses, I have seen this happen time and time again.

Business operators wait too long to find out important information, only to find out they don’t have enough cash.

With that in mind I recommend that you track your Gross Margin on a monthly- basis.

Step 5: How To Get Help From Your Accountant

As an accountant who is passionate about your corporate success, I urge you to seek regular council with an accounting professional who has a professional designation.

Because why do businesses lose profit margin without realizing it immediately?

There are many possible reasons including:

  • Price increases from your suppliers

  • A change in exchange rates

  • Inventory theft and more

An experienced accountant can help you figure out why your margins are dropping.

So don’t be shy. Pick up the phone and call your accountant to get their opinion. Their timely advice could help you earn a lot of money!

Conclusion

In this article we gave you definition of gross margin along with 5 steps you can follow to take advantage of the concept.

  1. Understanding Gross Margin
  2. The Gross Profit Margin Formula
  3. Where To Find Your Gross Margin
  4. Why You Should Track Your Gross Margin Every Month
  5. How To Get Help From Your Accountant

Now that you understand the importance of monitoring your gross margin you can set up a system to monitor it on a regular basis.

You can also consider investing in your accountant, who can not only help you troubleshoot, but also help you to maximize the overall profits in your business.

Picture of Paul C. Morin, PBA

Paul C. Morin, PBA

Paul brings over 25 years of experience from his role of a controller in helping midsize to large companies with their accounting, bookkeeping, taxation, and business development strategies.

Contact Paul

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