The Importance of Focusing on Gross Margins

Companies often think about net profit and net profit margins. However, they often overlook gross profit and gross margins, even though they may show these on the income statement. This is highly ill-advised. Being aware of and tracking gross margins are the first line of defense in maintaining profitability and identifying issues as they arise.

Companies need to focus

Gross Margin

Gross Margin is also (sometimes) referred to as Gross Profit. However, gross margin is quoted in percentage terms, whereas gross profit is quoted in monetary terms. i.e., A gross margin of 40% or a gross profit of $1.8 million.

According to Investopedia, Gross Margin is “A company’s total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. The gross margin represents the percent of total sales revenue that the company retains after incurring the direct costs associated with producing the goods and services sold by a company”.

Gross Margin Calculation

Gross margin (GM)  is calculated as follows:

gross margin calculation

GM represents the proportion of each dollar of revenue that the company retains as gross profit. For example, if your company’s gross margin for the most recent quarter was 35%, you would retain $0.35 from each dollar of revenue generated, to be put towards paying off selling, general and administrative (SG&A) expenses (aka overhead), interest expenses and making any distributions to shareholders. The levels of gross margin vary significantly from one industry to another depending on the business. For example, software companies will generally have a much higher gross margin than a manufacturing firm.

Gross Profit

According to Investopedia, “Gross profit is your company’s revenue minus its cost of goods sold. Gross profit is a company’s residual profit after selling a product or service and deducting the cost associated with its production and sale. To calculate gross profit: examine the income statement, take the revenue and subtract the cost of goods sold. Also referred to as “gross income”.”

When analyzing a company, gross profit is very important because it indicates how efficiently your management uses labor and supplies in the production process. More specifically, it can be used to calculate gross profit margin. See the example below for how gross profit indicates a company’s efficiency.

Example

Company A and Company B both have $1 million in sales. Company A’s cost of goods sold  (COGS) is $900,000 and Company B’s COGS is $800,000. Company A’s gross profit will be $100,000 and Company B’s gross profit will be $200,000. Company B spends less money to make the same amount of sales, and is therefore more efficient.

GROSS PROFIT AND GROSS MARGIN CALCULATIONS:

Motorcycle Sales

For  NEW Motorcycles/ATVs/dirt bikes, etc.:

GP = Sales price/Total invoice for motorcycle sales – (Motorcycle (or other) cost + associated fees+ cost of service hours spent readying/prepping vehicle + commission paid)

For USED Motorcycles/ATVs/dirt bikes, etc.:

GP = Total invoices for motorcycle sales – (Motorcycle cost + associated fees + cost of parts used to ready vehicle + COST OF service hours spent prepping vehicle + commission paid)

USED Car Sales

GP = Total invoices for vehicle sales – (Cost of vehicle + associated fees + cost of parts used to ready vehicle +  cost of service hours spent prepping vehicle + commission paid)

Parts

GP = Amount received for parts (i.e., sale price) – cost of parts

Service

GP = Service invoices paid by customers – cost of service and parts provided =  billed (cost of parts used + hours billed for service) – labor burden for mechanics – cost of parts

PRIMARY FOCUS: Mechanics’ hours actually billed – billable hours (mechanics’ hours actually worked)