One of the best things you can do for your small business is to learn how to calculate gross profit. This figure is what tells you what kind of money you have left after paying all of the business expenses that go toward manufacturing costs.
As you can see, it is very important for the good of your business to know how to determine your gross profit. Without it, you could very easily spend money that you technically don’t have. That’s why we put together this handy guide.
We will walk you through the process of calculating your gross profit so you have a clear understanding of what your business’s finances actually look like.
What Is Gross Profit?
Your gross profit is simply how much money your small business has earned after deducting all of the costs that are associated with manufacturing and selling your product. The formula is pretty straightforward. However, there are some things that need to be accounted for.
How to Determine Your Gross Profit
Calculating your small business’s gross profit consists of subtracting your sales from the expenses associated with making those sales. For instance, let’s assume that your income statement shows that your company made $100,000 in sales.
However, your cost of goods sold, or COGS, for that period was only $10,000.
Using the formula…
Gross profit = Revenue – COGS
…we could determine that your gross profit for that period was $90,000.
$90,000 (Gross profit) = $100,000 (Revenue) – $10,000 (COGS)
You would need to rely on that $90,000 to help build your brand and business. Whether making repairs around your store or improving business operations, your gross profit will help you take your company to the next level so that, ideally, it is even more profitable than before.
There are some components of this simple formula that need to be highlighted to ensure that you have a clear understanding of what it entails. These components are fixed costs and variable costs. Let’s take a moment to look at each.
Fixed costs are business expenses that remain consistent throughout the manufacturing cycle. These are expenses like building taxes, insurance, salaries, taxes, and benefits.
These costs are just the opposite. Variable costs can change throughout the manufacturing process. Some examples of variable costs include things like materials that go toward manufacturing, shipping costs, hourly wages, credit card fees, or sales commission.
Both fixed and variable costs play a role in determining the exact figure of your gross profit. Without them, you would have inaccurate data.
It’s also important for you to have a clear understanding of your costs of goods sold (COGS). Let’s explore this component a little closer, as well.
What Is COGS?
COGS is simply your fixed and variable costs, plus your total inventory. To ensure that there aren’t any disputes about what your costs of goods are, it’s important to keep a detailed history of all of your sales data.
This will ensure that nothing is overlooked or left out and that your gross profit calculations are consistently accurate and precise. The better your bookkeeping skills are, the better your gross profit calculations will be.
When it comes to business operations, this is an absolute must. You need to be able to determine your gross profit so that you know exactly what kind of funding to pour into different areas of your company.
Mistakes could lead to you not having enough money to pay toward other areas of your business, such as utilities or employee wages.
Many business owners have failed because they couldn’t get a handle on their finances. This is why it is so important to make sure that you take the time to learn formulas such as the gross profit calculation. When you have a firm understanding of where your money is going, you can make the best decisions for your company.
If you need help with these areas, you may want to consider hiring a professional business coach who can give you the direction you need to be successful. It will be an added expense, but it will pay off in the end.
Be sure to explore our helpful articles for more information on how you can be successful in your business ventures. Whether you hire additional help or not, the more knowledge you have about business finances, the better!
How to Calculate your Gross Profit Margin
When you know how to calculate your gross profit, you can easily determine what your gross profit margin is, as well. It’s good to know your gross profit margin, as this will tell you at what percentage your company is operating. This will, in turn, tell you how efficient your business operations are.
To determine what your gross profit margin currently is, you simply need to divide your gross profit by your total revenue. Then, just multiply the outcome by 100.
Using the values from above, let’s observe the formula for determining your gross profit margin.
(Gross profit) ÷ (Revenue) x 100 = Gross profit margin
Let’s use the figures from earlier so you have a better idea of what the end result looks like.
$90,000 (Gross profit) ÷ $100,000 (Revenue) = 0.9 x 100 = 90 (Gross profit margin)
Your company’s gross profit margin is a reflection of your efficiency in managing inventory. It also shows how well you’re allocating labor and if supplies are being ordered properly.
Maximizing Your Gross Profit
There is a lot that you can do to increase your business’s gross profit. But in order to effectively do this, you need to first determine your gross profit margin. Once you have successfully calculated this figure, you can move on to analyzing your profit margins.
It is certainly possible that your overall gross profit margin isn’t completely accurate. That’s why you need to take the time to analyze your gross margins to ensure that they are indeed factual.
One of the most common practices among business owners is to increase their prices. This is a fine line to tow, as you don’t want to risk running off customers and having them take their business elsewhere, like to a competitor.
Regardless of how much you raise your prices, you can count on losing a few here and there. The idea is that your increased costs will make up for any losses while increasing your gross profit margin.
Always take the time to review the prices of the products you sell. You may be selling something for far less than what it is worth. This is why it’s important to check out your competitors to see what they are up to. You may need to send employees out to scout other stores so you can get a better idea of what other people are paying for the same product.
As much as you may be tempted, try your best to avoid discounting items for customers. If you do it one time, it will be much easier to do it again. And again. If necessary, create a strict policy that says no discounts.
Every time you discount items, you are throwing off your gross profit. What’s more, you will need to make up for this in other ways, which won’t be good for business.
Another way to ensure that your gross profit remains good is to avoid competing with other businesses on prices. You want customers to shop with you because of the outstanding service that you provide. If you maintain this mentality, you will see more customers trusting your judgment and continue shopping at your business.
One of the most important things you can do for your business is to prevent theft at all costs. Theft can make or break a company’s gross profit, so be sure that you take extra measures to keep this at a minimum.
You should also invest in inventory systems to help you keep control of your stock. You need this assistance if you deal in a lot of inventory and it can help you to better manage your store items.
The goal is to keep close track of your inventory at all times. An inventory system will help you to better see when you are running low on an item and need to order more for your store. Running out of items is a great way to lose business, so you want to have a tight grip on your inventory.
Your ultimate goal should be to become comfortable with your business’s gross profits. Once you have this formula down to a science and are capable of getting consistently accurate numbers every time, you will have much easier management of your operations.
Then, you can move on to mastering your finances so that your business runs at its very best. It takes time and plenty of patience, but you can grow your business and be wildly successful by utilizing these formulas to your advantage.