In order to determine how well your company is performing financially, you need to calculate your gross profit margin. Although this is a relatively common metric seen in nearly every industry, not everybody knows the correct way to figure it out.
Fortunately, it’s not as difficult as you might anticipate. Let’s take a look at what you know about how to calculate gross margin.
What Exactly Is Gross Profit Margin?
As the name suggests, this term refers to the amount of money that is left over after factoring in both revenue and company expenses.
For example, let’s assume that your business generated $1 million in revenue in 2020. Although this number may seem substantial, this doesn’t mean that you generated $1 million in profit.
For this reason, entrepreneurs use calculations for gross profit margin in order to determine how well the business is performing.
How Can I Calculate It?
The formula for calculating this metric is relatively straightforward. You simply subtract the cost of goods sold from your net sales and then divide this amount by your net sales.
In practice, the formula looks like this:
Gross Profit Margin = (Net Sales – Cost of Goods Sold) / Net Sales
The end result is a percentage, which is a value that is far easier to work with than an integer. And, there are plenty of uses for this value.
Many people confuse gross margin with gross markup. This resource has the answer, you can check it out here.
What Information Can I Learn From It?
There’s a large amount of information that can be discerned from calculating your company’s gross profit margin. One of the most notable scenarios involves analyzing the performance of the company after key changes are made.
For instance, let’s assume that a business decides to make drastic changes in terms of workflow automation. If the processes are implemented correctly, your company would have a better profit margin since the cost of goods sold would decrease.
This value will then illustrate that your current practices are working.
This is a notably important metric to have on hand when communicating with potential investors or shareholders. It’s also commonly referenced by entrepreneurs who wish to sell their company, as it is a clear indicator of the type of performance that the buyer can expect.
Additionally, you’ll need to consider the history of your company’s gross profit margin. If this value fluctuates highly over a period of time, it could reflect certain internal issues that need to be addressed.
One of the most common is poor management, which could result in inconsistent sales performance.
Understanding How to Calculate Gross Margin Can Seem Confusing
But, the information listed above will ensure that you know exactly how to calculate gross margin effectively. Afterward, you have a comprehensive understanding of your company’s financial health and can ensure that you stay on the right path.
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