Gross Profit Margins and Financial Health

As a business owner, the success of our business is what we put a majority of our energy into. We look into a lot of different moving parts when it comes to checking the health of our business, but we tend to focus on the top line sales number. Of course, there is no denying that sales are important, but when it comes to goal setting, we should be giving more attention to our profits.

The Big Picture – Profit

Profits are a surefire way of measuring the health of your company. The most efficient way to ensure that you have a profit at the end of the day is to be mindful of your cost. Being mindful is easy and efficient if you have the right information. The first step of being mindful is to understand the cost related to producing and selling your product. When it comes to this, your Profit and Loss Statements will be extremely important. These statements will list out all of the cost that you need to pay attention to under Cost of Goods Sold and, in some cases, Cost of Sales. The cost of producing or sourcing the product, labeling, bagging, and other prep center work in addition to the shipping cost is included in Cost of Goods Sold.

Often, Cost of Sales is housed under the term Cost of Goods Sold; QuickBooks follows this setup. Cost of Sales includes selling fees from Amazon, PayPal, Stripe, and other merchant processors.

When using accrual or modified cash books, matching up cost of goods and cost of sales for the units sold will allow you to better see your profitability for each month. Your Profit and Loss Statement will have this listed as Gross Profit. This Gross Profit is calculated by Sales Revenue – Cost of Goods Sold – Cost of Sales. Your calculated Gross Profit will help in understanding your business health because it allows you to see your Gross Profit Margin (or often referred to as Gross Margin). The Gross Margin allows you to scale your numbers against the standard which in this case is 30% or higher. To calculate your Gross Profit Margin, divide your Gross Profit by your Sales Revenue and multiply by 100 to get a percentage.

If you are a new business 30% may seem high due to your low operating expenses. As you grow, your expenses will also grow and 30% will not seem as daunting. With growth, you will find that you have to pay for infrastructure such as employees, warehouses, software, etc. An additional added expense will be a product launch “machine” you will want to have in place. This machine will be used to ensure that you are consistently keeping up with the growth curve.

In the end, the goal is for sales to generate enough gross profit so that you will not need to rely on debt to purchase and market your products.

No Debt, No Problems

As debt grows it will begin to take away from the cash you will need to use to pay for growing your business.  As your business grows, there will be a few things you will want to ask yourself: “What can you do to ensure and build the success of your well-performing products?” or “Can you increase prices and get them up to par for poor performing products, or is it time to cut them loose?”

If you have a lot to evaluate, and it seems overwhelming, try using the 80/20 rule. Start with the top 20% and the bottom 20% product performers. Work on those that need attention for a month or two, then take the next 20% from the top and bottom. By working through them systematically, you can move the needle on your profitability and get set it to grow.

Interested in Profit First?

If your ecommerce business isn’t where you’d like it to be in terms of profitability, check out my book, Profit First for Ecommerce Sellers. It answers important questions about how to implement Profit First in an ecommerce business. Take control of your money and your business, and put Profit First to work for you! Contact bookskeep today to learn more about accounting for ecommerce businesses.