There are so many ways to justify a personal expenditure of a new suit, new bag or briefcase when you are in the design field. After all appearances mean so much don’t they? Our work is judged by how we look and come across, isn’t it?? Especially when we “know” we made profits on our last couple of jobs we should be able to allow for a splurge, right? Don’t we need to celebrate a new contract with a delicious lunch after an appointment?? Isn’t that what return on investment is? Or was that petty cash or owner’s capital – a tax deduction? Whatever!!
In this first of a series on taking your business’ financial temperature lets drill down on the first element of finance: gross profit margin.
When we view our profit on a job or our profits from the last quarter all it says is that __?___dollars were made. This is gross profit stated in dollar amount. It’s a hard, cold figure. But sometimes we don’t see the baggage it carries with it and our responsibility to that baggage. The gross margin, or gross profit margin, is that dollar amount as a ratio expressed as a percentage of our sales minus the cost of those goods we sold. It doesn’t show you what is in all the other bags, but it does give you a clearer picture of your profit and its relation to the products you sell. It also is a basis to establish your markup, which we will get into in another article.
If the cost of the goods we buy, or labor to make them, increases over time, the gross margin will help you see that you also must raise your prices to your clients. By the way, cost of goods, although not taking business operating expenses into account does include variable costs you accrue depending on the kind of business you run. If you are a workroom, these costs will include materials, direct labor such as sewing the product or installation, depreciation on machinery and freight expense. We have all been impacted by the past recession and it has caused us to seek out better alternatives to keep our cost down. As a business person, our responsibility is to find the best source which offers a better product or services requiring less time, greater turnover, travel or cost on our part. This will increase your gross margin.
Another way to increase your profit is to take the risk of offering a discounted sale on some of the goods you sell, trying to attract more buyers. If it does attract new clients, your volume of sales can offset the discounted price and increase your gross margin. Packaging services together at times and offering the upgrade like “…would you like to add a dessert to your meal…” can also be a profitable option. If time limits are offered whether on the end date of a sale or as an incentive to pay an invoice by a set date, you can often sell more or collect more quickly. View this as another relationship in your business. Seeing the gross margin as a relationship between what was a successful sell, how much it cost you, and how much you sold it for will help you evaluate whether each particular product or service you offer is a worthwhile profit center.
We need to keep in mind that even though profits rise, if the gross profit margin stays the same, we aren’t any further ahead. One of the first signs of financial trouble is the coinciding of increasing gross profit with a declining profit margin. If the gross profit margin is higher, it means you have found ways to stabilize or decrease the cost of the goods sold and you have a healthier company. The cost of doing business doesn’t enter into calculating the gross profit margin – only the cost of goods sold. However, if you offer discounts they have to be figured into your formula which “refine” your gross profits and are called net sales. Your net sales are your total sale (gross profit) minus discounts/ deductions, any returns or damaged goods. The net sales are often recorded in lieu of the gross sales on an income statement as gross sales alone can overestimate the financial status of the business. Down the road, your company will be valued by your accountant and investors based on the net sales figure because it shows how stable the sales growth actually was.
So – to clarify:
Sales minus Cost of Goods equals Gross Profit
Gross Profit Margin is the Sale minus the Cost of Goods divided by the Sale
Net Sales equals Gross Profit minus deductions, returns and damages