Why It is Essential to Know Your Gross Profit Margin

Posted 27 Apr '22

When asked about their gross profit margin (GPM), most business owners have some idea of how many products or services they need to sell in order to come out ahead. However, very few can share definite numbers to describe how much they need to make to break even and how much they need to make to generate a profit.

Although it is possible to keep business doors open without knowing and monitoring the gross profit margin, this isn’t a recommended approach to manage your money! In fact, it goes against best practices and is a sure way to lose track of how much your organisation is bringing in versus how much it costs to operate your business.

Knowing your gross profit margin can play a pivotal role in the health of your business. Check out our comprehensive explanation of what a GPM is exactly and how this information can be used to drive important decisions for your business!

What is a Gross Profit Margin?

Although many business-related formulas can be quite intricate, calculating a gross profit margin is relatively simple. As defined by the WallStreetPrep, “The Gross Profit Margin represents the amount of revenue left over after deducting the cost of goods sold (COGS) incurred in the period.”

To appropriately calculate your GPM, you must know the overhead amount of how much it costs to run your business. This includes the raw materials you use to perform a service or even the initial cost of the products you sell.

Understandably, as the cost of raw commodities and products goes up and down from season to season, businesses should expect to continuously recalculate their GPM throughout the year. By doing this, you are keeping yourself current and updated on how well your business is performing.

The GPM formula is written as: Gross Margin = (Total Revenue – Cost of Goods Sold)/Total Revenue. However, to ensure all appropriate aspects of your finances are considered, it is a good idea to consult with a professional.

The accounting experts at Empire Accountants are well-versed in helping business owners from all industries figure out their GPM and leveraging that information to grow.

Why Do I Need to Know My Gross Profit Margin?

Knowing your Gross Profit Margin will tell you exactly how much money you need to make on each sale to continue to turn a profit. Rather than blindly conducting business day-to-day without a goal, knowing your GPM will give you a number to strive for to ensure your company is making a profit.

Real-World Example

Let’s consider the business flow of a carpenter who has overhead expenses such as apprentice wages, superannuation, insurance, and even raw materials such as wood or nails. These overhead expenses cost around $200,000, and the carpenter knows that his gross profit margin is 25%.

To break even, the carpenter knows that he needs to make at least $800,000 in sales. However, he can increase his margin by 10% and, after running the numbers again, sees that his business has the potential to earn $80,000 in profit.

Without tracking his GPM, that contractor may have continued running his business, not knowing that at the end of the day he was working for zero profits! As you can see, even a 5%-10% increase in the gross profit margin of a business can make a tremendous difference in the overall profitability of the organisation.

Consult With A Professional

The two most important metrics to know about your business are the gross profit margin as well as the cost of your overhead expenses. If you know these two numbers, you’re capable of making well-informed financial decisions for your business.

For more information about how to calculate your gross profit margin, please Reach Out to the accounting professionals at Empire Accountants. We’ll help you review your overhead costs and calculate your GPM so that you can run your business with confidence!