Really Understanding Your Gross Margin
Let’s talk about your Gross Margin. Do you know the margin on the stock you sell or the services you offer? And if you do know, do you track its development? Often, I receive a yes to the first question, but the second questions is met with a blank stare or we’re told, I don’t need to, it doesn’t change. My response is always, are you sure about that?
So first things first, for those that aren’t all over it, let’s go over what a Gross Margin actually is. In a nutshell, your gross margin is the difference between what you invoice a customer for a product, and what you paid the supplier for that product, plus your on costs (inbound freight, duty, packaging ect). Different industries will have different margins on products, however your margin should be at a level that it covers your overhead/fixed business costs and leaves you with a reasonable profit.
Gross margin can be calculated as follows:
Total sales – Cost of goods sold
Gross margin % is:
Total Sales – Cost of goods sold/Total sales x 100
Gross margin is one of many KPIs that businesses can track (learn more about KPIs here), and to get the most out of it you should track your gross margin development month on month and understand why any fluctuations occur. Common reasons for movement in your margin from month to month include:
Sales mix – you might have months where you sell more of an item where you make less money than others, or vice versa where you sell more highly profitable items. In the first instance you might see an overall decrease in your margins, whereas you may see an increase in your gross margin % in the later example
Promotional activity – Got a hot offer for new clients? Selling lots of discounted stock? Offering a 2 for 1 promotion? All of these examples will result is some form of margin erosion, unless they are balanced out with increased sales of more profitable items
Foreign exchange fluctuations – for those of you that purchase stock offshore, fluctuations in exchange rates will have an impact on margins. If for example the AUD drops, it will cost you more to purchase the same stock in comparison to earlier periods and unless this cost is passed on to customers by way of a price increase, you’ll take a hit at margin level
Price increases – if your product costs remain the same and you issue a price increase to customers, expect to see an increase in your margin which is equivalent to the price increase. Alternatively, if your suppliers increase purchase prices and you don’t pass it on to customers, expect to see a reduction in your margin.
Your gross margin is one of the best indicators of business profitability. The most successful businesses have strong margins and a detailed understanding of how internal and external factors can have an impact. Armed with this information, business owners are in a great position to make informed decisions and respond to movements, both good and bad.
If you have any queries about your Gross Margin or would like some support gaining a better understanding of movements, touch base at info@brambleandbriar.com.au.