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Aug 31Doug Smith

That is So Gross! | Tips For a Healthy Gross Margin

Aug 31Doug Smith
Gross Margin

Metrics Make the Difference

In business, we talk a lot about “the bottom line,” but have you ever wondered how deep that bottom goes? While a company’s profit, or net margin, is the net amount left over at the end of business day, the amount of that net margin is affected by factors much higher up on the income statement.

In my B2B CFO® work, I often work with clients to reduce their indirect costs (e.g., selling, marketing, distribution, warehousing, and administrative). This month, I want to move even higher up the income statement, and talk about I work with them on the factors that affect gross margin (GM).

Simply stated, GM is the revenue earned from goods and services sold to customers, minus the costs of those products or services. It is a critical measure in any business. A rising GM (stated as a percent of sales) is the result of good business decisions made about the prices and costs of your products and services.

What is definition of a “healthy” GM? First, GM must be sufficient to cover all those indirect costs. It must also be sufficient to generate respectable net income even after the indirect costs are paid.

GM percentages vary widely, depending on the company’s industry. In a distribution business, a 30% GM is attractive. In manufacturing 50% GM is a reasonable goal. Service firms that add real value to their clients can enjoy an ever high GM. No matter what industry, it’s important for the business owner to know the industry average, and seek to be at or above it.

What can be done to increase gross margin? The business owner has multiple levers to pull to bring it up. The most obvious levers are increasing prices of the products and services the company sells, and reducing the costs of those products and services (usually called Cost of Goods Sold, or COGS). Some of the less obvious levers are:

  • Managing the mix of products and services sold to customers, focusing on both volume and profitability of each line
  • Refreshing the mix of services, adding new products and services that are less commoditized and thus can command a higher price
  • Taking advantage of discounts offered for paying suppliers early (if the company’s cash flow is sufficient)
  • Negotiating volume discounts with suppliers, or asking for either volume or trade rebates

Oftentimes it takes more in-depth data mining and analysis to undercover opportunities to improve GM. Detailed cost accounting can tell the owner more about the true cost (and underlying GM) of particular products and services. The owner may discover that, although the overall business is profitable, some product/service lines are losing money, and should be phased out. The analyses may also reveal opportunities to increase prices to particular customers, based on the overall value provided.

Having a health GM enables a business owner to focus on growing the business, not simply surviving or staying static. And highly profitable businesses have greater value at the point of business exit.

If you would like some assistance thinking about your GM and how to improve it, please don’t hesitate to give me a call or email me at dougsmith@b2bcfo.com .

photo credit: The Hand That Feeds via photopin (license)

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