When you look at your accounts, can you read your profitability? Here are some things to look for.
| Gross profit | Gross Profit = Net Sales - Cost of Goods Sold |
| On your balance sheet, gross profit is the difference between revenue and the cost of goods sold (or services provided). It generally appears before administrative expenses and general overheads are accounted for. Ideally, gross profit covers your overheads as well as generating your targeted profit, your net profit. | |
| Net profit | Net Profit = Total Revenue - Total Expenses |
| Net profit is what you’re going for – it is the actual profit after all expenses and overheads have been paid. Net profit is the bottom line. When you are assessing your business’ actual profitability, bottom line tells you a lot (it is, after all, the bottom line). | |
| Gross profit percentage Gross profit percentage is a percentage of sales and it’s a valuable metric to keep hold of. It is the ratio of your gross profit in proportion to your sales: Gross Profit % = Gross profit / Sales x 100 / 1 Now that you’ve calculated it, what are you going to do with it? For a start, calculate your breakeven point: |
| Breakeven point (see our article here on using breakeven point strategically) Breakeven = Total Expenses / Gross Profit % x 100 / 1 |
What does your gross profit percentage tell you?
Gross profit percentage is a useful indicator of production efficiency and financial health. Ideally, it is fairly stable, barring drastic upheavals in your business or industry. A drop might mean one of a number of factors which need to be corrected, such as a rise in costs, waste or bad debts.
In a competitive market, where benchmarking data is available, you might compare your business’ gross profit percentage to that of your competitors and take steps to make sure you keep your edge. Gross profit percentage can vary widely across different industries. For food and beverage businesses, for example, it’s a very thin margin while for software businesses it tends towards the high end.
Changes in gross profit percentage might also mean increased competition in the market or increasing demand from customers for discounted products or services. It could be a response to changes in the business, such as expansion driving increased production costs or a higher wages bill.
Keeping track of your profitability gives you the big picture on your business. The key metrics that indicate profitability are all windows onto the big picture. Understanding them will help you set goals and drive growth.