Most entrepreneurs and small business owners manage their own finances.
Owning and managing a business is complicated at times. Managing your business will require you to have a good understanding of administration and finance.
While managing your finances can be complex, there are a few basic formulas you should know. One of the most important to keep in mind is the gross profit margin.
Interested in learning more about the gross profit margin formula? You’re in the right place. Here’s a simple guide on gross profit margin and how to calculate it.
What Is Gross Profit?
Gross profit is a simple financial metric that shows you how much profit you have made. In simple terms, your gross profit is the money that is left after you have paid your dependent costs. These dependent costs are not your business's total costs but the variable costs related to the sale.
For example, if your business buys chips and resells them, the gross profit is the difference between the selling price and the price you paid for the packet of chips. This metric should not be confused with the net profit margin as that includes the fixed costs and overheads related to running your entire business.
See Also: Financial Metrics Dashboard: What KPIs Should You Look For?
Why Is Gross Profit Important?
As a startup owner, you will often need to be the head of multiple departments. You can quickly find yourself being the official buyer, lead product developer, customer service rep, marketer, and accountant. While these roles are all important, the most important is the financial management of the business.
After all, this is where you tally up expenses and calculate how much profit you have made. These numbers can often be confusing. This is why there are a few important financial ratios used to compare and contrast your business’s finances accurately.
One of the most important ratios is the gross profit margin. This is important for businesses as it will let you know how much profit you are making in an easy-to-understand way. Companies can calculate this percentage and compare it to other businesses, products, or industries.
This information can be incredibly useful as it can help guide business decisions. If the gross profit margin on a particular product is lower than another product, you could increase your overall profits by stocking more of the second product.
How to Calculate Your Gross Profit
Calculating your gross profit can help indicate how well your business is doing. This can also show you whether a particular product is doing well or not for your business. To calculate your gross profit, you need your product's selling price and the cost to produce it.
The gross profit formula can be used to find out the total gross profit for a single unit, an entire product, or the total gross profit for your company. Here’s the simple formula for calculating gross profit:
Total Sales – Total Cost of Sales = Gross Profit
It’s important to note that the total cost of sales is only the costs associated with producing or purchasing that specific product. This is what differentiates gross profit from net profit.
What Is a Gross Profit Margin?
While knowing the gross profit is useful, expressing it as a percentage is more beneficial. This is because large numbers may not always be as positive as you may think.
For example, a company that makes $1 million may look like they are more successful than a company that only makes $100k. However, if the first company has to spend $900k to make that $1 million, it’s actually worse off than the second company that needs just $10k to bring in $100k.
This is why the gross profit margin is so important, as it takes this into account when comparing your business's finances. You can also compare this percentage with other businesses in the industry to figure out how well your business is doing.
What Is the Gross Profit Margin Formula?
The gross profit formula requires you to know the total net sales (or total revenue) and cost of goods sold (COGS). Once you have these, you can plug them into the gross profit margin formula to calculate the percentage. Here’s what that would look like:
(Net Sales – COGS) / Net Sales x 100 = Gross Profit Margin
See Also: Understanding the Difference Between Revenue and Income
How To Calculate Gross Profit Margin
When calculating your gross profit margin, it helps to work step-by-step. To help you, here’s an easy guide without all the financial jargon to walk you through the steps.
Step 1: Total All Invoices
The first thing you need to do is total up all your invoices to calculate your total sales. To accurately depict total revenue, you should subtract any returns, allowances, and discounts from this figure.
Step 2: Total All Receipts
The next step is to add up all your operating expenses and production costs. This figure should be accurate and take returns into account as well.
Step 3: Calculate Your Gross Profit
Simply subtract your expenses from your total income to calculate your gross profit. This figure will make calculating your gross profit margin more straightforward.
Step 4: Calculate Gross Profit Margin
To calculate your gross profit margin, plug in everything you have figured into the profit margin formula. This will give you a simple percentage to compare with others in the industry.
Zeni’s Finance Team Can Help Answer Your Questions
The gross profit margin formula is important to running your business successfully. This metric does not just let you know how much profit you’re making but can help you adjust your prices and even evaluate your investments.
Our experienced financial team is skilled in consultancy and financial management, making us an ideal long-term partner and the one-stop shop for all your accounting needs. Plus, we have AI technology backing our every move so that you can have a more real-time pulse on your finances.
If you have questions or want to learn about Zeni’s capabilities, please book a demo with us today.