Gross profit is a key indicator of your business’s overall health, so keep reading!
Measuring and monitoring your gross profit regularly will tell you a LOT about what’s happening in your business and how you can make more money.
So firstly, what is gross profit?
Gross Profit =
Cost of Goods Sold
It’s usually represented as a % of sales.
Generally, the higher the gross profit % the better.
Gross profit can be measured for your business overall and it can also be used on a more detailed level for eg. per product line, type of customer, location etc.
Why is gross profit so important?
Gross profit is the amount of money left over from sales to cover your overhead expenses (electricity, rent, insurance etc). In most cases your overheads are relatively fixed and there’s not a lot that you can do about them. Not the same for gross profit!
Measuring and monitoring gross profit and investigating significant fluctuations allows you to know exactly where, how and why changes need to be made so that you can make more money from each sale.
It’s imperative to understand what your most profitable and least profitable product/service lines are. You may use the information decide to stop offering unprofitable lines and/or decide to “push” your more profitable lines in your marketing for example.
What should you be looking for?
Gross profit should remain fairly stable over time. If it fluctuates significantly downwards it’s an indicator to further investigate for things such as possible fraud, accounting irregularities, mismanagement or perhaps increased competition. If any of these are the case, it’s obviously best to sort them out ASAP.
If your gross profit fluctuates in a positive way, it could indicate an improved product mix shift, better buying decisions or improved efficiencies. It’s good to know these things so that you can keep doing them!
So it makes a lot of sense to keep your eyes firmly on your gross profit right?
- Determine your overall business gross profit and monitor it regularly (eg monthly)
- Determine the gross profit of your individual product /service lines (and even by location, customer type, business divisions if possible) and monitor regularly.
- Make an effort not to discount or compete on price. Instead, look for ways to differentiate your offering on another basis eg. turnaround time, availability of support, ease to buy etc
- Review your supplier’s invoices regularly to ensure quantities and prices are correct and are reflected in your sales model (know in advance when supplier prices have been pushed up so that you can consider raising your sales price)
- Have strong systems in place for stock/materials. If stock goes missing for example or you have a lot of wastage it will affect your gross profit. If reporting is incorrect it will also impact your gross profit. If stock is obsolete or slow to move, then consider dumping it.
- Measure and monitor!!!
Knowing exactly how your business is performing NOW is arguably one of the biggest keys to improving your business performance in the future.
With the development of cloud accounting, all the information is at your fingertips on a timely basis. You just need to use it!
Case study: Retail shop owner wants to better understand shop sales and usage of employees.
Business owners start to know this kind of information in their head ie how much the shop would generally take on any given day. However, it’s not much use to anyone up there!
Action: With a few changes to the data entry process, this information can easily be gathered, tracked and then reported on using the xero accounting system.
I have recently set up xero to track “daily shop sales” for my client. By also using the timesheet function, we can then start to report the use of employees v the revenue brought into the business on any given day.
Benefits: These changes will enable us to see –
- Which days generally bring in more revenue than others
- Which days typically require more labour
- Which (if any) employees are more productive than others
- How many sales (quantity) were made on a particular day
- What the average sale was on any given day (and any period of time)
Value: The business owner is now better equipped to determine rostering requirements and potentially save money on days where additional labour is not required, or perhaps schedule time for themselves on those quieter days to conduct any training and work ON growing the business.
Ultimately, by tracking the $ value of sales, # of customers in the store and the average value of each sale we can also now track the effectiveness of any sales strategies that are implemented.
Worthwhile exercise don’t you think?!
Take Home: What could you be tracking in your business to help you “join the dots” and move your business forward?