Gross Margin

If you’re not an accountant or bookkeeper by trade, financial reports may feel confusing. What are all these accounting metrics, and what do they mean for my business?

That’s why we’re taking some time to define the accounting metrics that are most important for small business owners to understand. This week, we’re focusing on gross margin.

Gross margin is one of our favorite accounting metrics here at BookWerksTM. It is calculated by subtracting what your product or service cost you (Cost of Goods Sold, or COGS) from what you sell your product for (Revenue). We typically express this as a percentage of revenue.

For example, if you sell an item for $9 that costs you $6 to produce, your gross margin on that item is $3, or 33.3%. In a mathematical equation format, it will look something like this:

Revenue – Cost of Goods Sold = Gross Margin

$9 revenue – $6 cost of goods sold = $3 gross margin

$3 gross margin is 33.3% of the $9 revenue, so the gross margin is 33.3%.

Another way of looking at this? When you have a 33.3% gross margin, you retain $0.33 from every dollar of revenue you generate.

A Higher Gross Margin is Good for Small Businesses

The higher the gross margin, or gross profit, the better for your business.

A high gross margin gives entrepreneurs more room for error and experimentation. The higher the gross margin, the more capital a company retains. This extra money can be used to pay other costs or satisfy debts. Gross margin funds can pay general and administrative expenses, interest fees and dividend distributions to shareholders.

Who has Good Gross Margins?

Gross margin varies by industry. Service-based industries tend to have higher gross margins, as they don’t have large COGS. On the other hand, the gross margin for manufacturing companies is often lower, as they have larger COGS from buying the materials for manufacturing products.

If your small business is prone to low gross margins, don’t worry. There are ways to make up for low gross margins in other areas for the business. For example, distributorships make up for low gross margins by relying on high volume revenue and low general business costs to turn a profit.

There are ways to make up for low gross margins. Distributorships, for example, usually have low gross margins, but they rely on high volume revenue and low general business costs turn a profit.

Good professional bookkeeping services will keep an eye on the trend in your gross margin over time, with the goal of making continuous improvement.

You can improve your gross margin through:

• Less expensive materials
• Less expensive labor
• More efficient production
• Selling at higher prices.

Ready to Outsource Bookkeeping? Reach Out for Support.

If tracking expenses and calculating gross margin gives you a headache, stop suffering! Reach out to a small business bookkeeper like BookWerks™ for support. Our financial experts are here to help you manage your finances so that you can save time, money, and stress. When you know you have a partner in cash flow management and tax preparation, everything else gets easier.

Learn more about our services by setting up a NO COST, NO OBLIGATION intro call.