Running a business can seem deceptively simple at first. All you need to do is create a product or provide a service, charge people for it, and ensure that you are making a profit in the process. Simple, right?
While this is the general idea, there are many finer points to consider, and these finer points can make or break your business. One of these things is the gross margin or the gross profit margin.
You can calculate the gross margin of your business by using a gross margin calculator. However, for the calculator to give you the correct result, you must enter the correct inputs.
Understanding these inputs to the margin calculator and other similar terms can not only help you get the correct gross margin, but it can also help you understand the impact of the gross margin on your business.
Here is everything you need to know about gross margin and the factors that impact it before using a margin calculator.
In simple terms, gross margin is the percentage of revenue that exceeds the cost of goods sold. Typically, when talking about how the business is doing, many entrepreneurs refer to the profit or gross profit.
Gross profit is calculated by subtracting the cost of goods sold from the revenue. While it is an important figure, it does not offer a complete picture as your profits will be used to pay your employees' salaries and other fixed expenses.
Simply calculating the gross profit does not tell you if you have enough to cover these expenses. Also, the gross profit is an absolute number whose implication can vary depending on the size of the business.
If you are a home baker, then a few thousand dollars in profit a month might be good enough. However, if you are a bakery that employs various others, the same figure is not good enough anymore.
Gross profit margin can be calculated as the gross profit divided by the revenue. Since it is in terms of a percentage, it becomes easier to understand the implication of the margin irrespective of the size of the business.
A high value from the gross margin calculator indicates that the company is generating a significant amount of profit.
The result from the margin calculator is also an indicator of how likely you are to break even and generate profits beyond the break-even point.
Since it is a measure of how much money your business has after paying for all the fixed and variable costs associated with making a product or providing a service, you can think of it as the money you have remaining to invest in your business's growth.
Gross margin is also a great way to get a real picture of how your business is doing. While it may seem like you have a lot of customers and are getting regular orders, if your gross margin is low, it means that you're still not making enough profits.
This can either be because the cost of your raw materials is too high or because you are not charging enough for your goods and services.
Since the two values that will be used to calculate the gross profit margin by the calculator are revenue and cost of goods sold or COGS, it is important to know how to arrive at these figures.
Revenue is how much money your business makes by selling its goods or services. You can find it by adding up the selling price of every product or service you sold in the period under consideration.
The cost of goods sold or COGS can be calculated by adding up all the costs directly related to producing the goods. However, it should not include the cost of marketing the goods or indirect overhead costs. COGS includes the cost of materials, labor, and manufacturing overheads.
You should also note that while calculating the COGS, you should only account for the cost associated with producing the goods sold during the period under consideration. For example, if you calculate the gross margin for a quarter, you should only consider the COGS for the goods you sold during the same period.
As there are many different costs involved in running a business, it might be confusing to determine exactly which ones you should include while determining the COGS. When you think about how to calculate gross profit margin, finding the revenue is straightforward, but most people get stumped while determining the COGS.
Let us look at a few other costs involved in the business and understand how they differ from COGS.
Cost of goods produced is a term that is often used by those businesses that manufacture goods. What if your business does not manufacture any goods and provides a service instead?
In that case, you should consider the cost of services or COS while calculating the gross profit margin. You can calculate the COS by determining the salaries of the employees involved in providing the services.
Since the business sells services instead of products, you will enter the value of COS in the margin calculator instead of the COGS. The revenue calculation remains the same.
You can include the cost of raw materials required to provide the service in the cost of service. If you had to transport personnel or certain products to provide the service, then you need to include the cost of transportation and shipping in the cost of service.
Since there is no inventory for services, you should consider the cost associated only with the services your business provided for the period under consideration to find the gross profit margin. These are the values you should use in the gross margin calculator.
While the cost of goods sold or the cost of services covers the costs directly associated with manufacturing the goods or services, many other costs are involved in running a business. These costs are equally crucial to sustaining it and fall under the operating expenses.
Operating expenses include the salaries of those employees who are not directly involved with making the product or providing the service. The salaries of staff in the HR and accounting departments are usually included in the operating expenses.
Operating expenses also include sales and marketing costs. The cost of utilities, rent, maintenance, and repair of the office premises are all part of the operating expenses.
You might often hear the term operating cost of a business. Operating costs are the costs associated with the business' day-to-day running. You can think of it as all the costs involved in running the business, including the COGS or COS and the operating expenses.
There is another type of expense associated with running a business, which is administrative expenses. Administrative expenses are not directly related to a particular department. However, these are essential to ensure that the business stays open and running.
Operating and administrative expenses may sometimes overlap. For example, the salary of the receptionist can come under both categories. The same can be said for the cost of office supplies and utilities.
While the result you get from the gross profit calculator and the margin calculator is vital to the success of your business, arriving at these values requires time and resources.
Browsing through your sales records, bills, and payroll and determining these values can suck the energy and creativity out of you. If you are running a creative business, you need to save all your energy for your creative endeavors instead of focusing on bookkeeping.
Fincent can help you here. The experienced, well-trained, and qualified professionals at Fincent can handle all your bookkeeping so that you are free to pursue those aspects of your business that truly deserve your attention.
Instead of thinking about how to calculate the gross profit margin, you can now think about how to improve your business offerings. Fincent assigns a personal bookkeeper to your business so that you always get an accurate picture of its financial health.
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