In a previous article, I covered the income statement, a financial report generated by your bookkeeper that includes your business’s Gross Profit. Your Gross Profit is an amount that you should be aware of each month because it can be used to measure your business’s profitability.
Although it has a grandiose name, your “Gross Profit Margin Percentage” is easy to calculate and is a measurement of your business’s profitability.
The formula is simply:
Gross Profit Margin Percentage = ( Gross Profit / Sales ) x 100
In order to be able to calculate your Gross Profit Margin Percentage you need an accurate Gross Profit. Your business’s costs will therefore need to be split into Cost of Sales and Overheads because your Income, less your Cost of Sales, gives you your Gross Profit. Your Overheads are treated separately and are taken away from your business’ Gross Profit in order to reach the Net Profit on which your business’s tax is calculated.
e.g. XYZ (Pty) Ltd earned R20 million in sales & incurred R15 million Cost of Sales
The Gross Profit would be R20m – R15m = R5m
The gross profit percentage would be (R5m / R20m) x 100 = 25%
This means that for every Rand that XYZ (Pty) Ltd earns, it really has only R0.25 at the end of the day.
Most bookkeeping software has the functionality to allow a Gross Profit to be calculated per product or service that you sell. This is very useful because you can then calculate the Gross Profit Margin Percentage for each of your products/services. The higher the Gross Profit Margin Percentage, the better, so if your most profitable products or services are not selling well, it may be worthwhile spending some money on marketing them. Conversely, if you discover that your best sellers are not making much money (or even losing money), you will have the opportunity to do something about it.
On an aside, if you calculate your business’s Cost of Sales as a percentage of its income and you know the ‘standard’ Cost of Sales percentage for your industry, you have a good tool for measuring the performance of your business. You can lower the percentage Cost of Sales, thereby improving your business’s Gross Profit, by either increasing your selling prices or reducing your Cost of Sales. As a business owner, it is vital that you include a contribution to Overheads when costing your business’s products and services. Otherwise, your products or services can make an attractive Gross Profit but it is eaten away by your Overheads, potentially to the stage where your business is making a loss.
Allocating your Cost of Sales and Overheads as accurately as possible means that …..
your Gross Profit is reliable which means that …..
you can measure your Gross Profit Percentage which means that ……
you can make fact-based business decisions about your products and services.
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