The importance of Gross Profit Margin
04 February 2020
Gross profit margin is often the most underutilised and least leveraged number in a small business. Understanding and getting on top of it will dramatically improve your productivity and your net profits.
Your gross profit margin is a measure of how much money you have left from every sale after you take out what it cost you to produce or acquire the product or service you sold.
Gross Profit Margin calculation example:
- ABC Limited has annual sales of £1 million.
- Their cost of sales is £500,000, giving them a gross profit margin of 50%.
- Their fixed costs (overheads etc) are £250,000 per year which leaves them with an operating profit of £250,000.
- If ABC Limited were able to go from a 50% to 55% gross profit margin by more efficiently managing the way they fulfil a sale, they would earn an extra £50,000 in operating profit.
- This 10% improvement in gross profit margin equals a 20% increase in operating profit.
|Cost of sales||500,000||450,000|
|Operating profit increase||50,000|
|% profit increase||20%|
So how do you improve your Gross Profit Margin?
Here are five suggestions for you to consider:
1) Improve velocity
The faster your turnaround time, the lower the cost of sale. This is especially true if you are a service-based business employing people to deliver the service you are selling. Look at the way you fulfil a sale and identify areas to speed up the process. Can you automate or standardise steps in the process? Can you remove unnecessary complexity and have less steps?
2) Process discipline
It is all very well having a well-defined process, but if you don’t stick to it and work hard to improve it, then it’s a waste of time. If you can, include the people implementing the process to contribute to its improvement. They will know what is taking the most time and slowing things down. Be strict on adhering to the process you come up with.
3) Cut out low-margin sales
Make sure you can identify and report on the jobs / sales / customers that deliver the lowest margins. This requires accurate and timely management information which you might need to sort out before you begin cutting out the low-margin sales. Once you have identified them, focus your investment and activity on the sales that deliver the highest margins.
Losing customers damages gross profit. It will cost you anything from 6 to 7 times more to attract a new customer than to retain an existing one (source: thinkjarcollective.com). You need to do all you can to keep your customers actively purchasing from you. Do you have a customer retention strategy or process? Perhaps you need to improve communication after purchase by scheduling a regular visit or phone call?
5) Invest in your systems
Do you have systems that support your processes and will grow with your business? Or are you having to muddle through with workarounds and awkward add-ons? Choosing the right software solution is critical to tracking, managing and improving GP margin.
These are just a few examples of how you can improve your GP margin. Hopefully they have given you some food for thought.
To discuss how business process management software can potentially improve your GP margin, please get in touch.