Melissa Jacobs explains the importance of gross profit (GP) – a very important number and metric that every business owner should track on an ongoing basis.
Let’s start by explaining what gross profit is. It is the profit made after deducting the direct costs of producing or buying the goods or services being sold. It is found in the income statement, and the formula to arrive at it is Sales – Cost of Sales = Gross Profit.
Gross profit is very important for two reasons:
• It is the first level of profit (if this is too low, you are going to have a problem).
• It is what’s left to run the business on, ie, the gross profit has to be sufficient to cover all your overheads and have enough left over for profit.
Example: Let’s say your business sales for the month were R1 000 000 and your cost of sales is R600 000. That means your gross profit is R400 000 (and 40%). That R400 000 has to be sufficient to cover your business overheads for the month and leave enough for profit. In this example it means for every R1 of sales, you make 40 cents gross profit.
If your GP % (gross profit t/sales) varies from month to month, you need to analyse it to find out why. Reasons for GP % fluctuations vary, but here are the main ones:
• Your suppliers increased their prices and you didn’t pass this on to your customers;
• You ran some promotions or specials, or gave discounts in the month;
• Your sales mix changed, ie, the proportion of lower margin products to higher margins products sold in the month changed;
• You have theft or wastage happening in your business.
Don’t just accept a fluctuation in GP % without getting to the bottom of why.
Let’s assume your average GP % is 33% and you want to increase this to 35%. You have three levers to pull in this regard:
1. Increase your selling prices;
2. Negotiate better pricing with your suppliers/ reduce input costs;
3. Sell a higher proportion of higher margin goods and services in relation to lower margin goods and services.
OUR OFFER TO YOU
At MJ Chartered Accountants we have the expertise to analyse and guide you on the management of your gross profit. Reach out to us by sending an email to email@example.com, and schedule a complimentary session with us to discuss your current GP and how you can improve it.
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