Evaluating gross profit margin is difficult because every business is unique. For example, companies prioritizing sales volume amongst their strategies or operating in highly competitive markets trend towards lower gross profit margins despite maintaining healthy finances. Industry-specific baselines and the context of your broader strategies are critical to gaining insight from your gross profit margin. Without these pieces to the bigger puzzle, individual businesses will have a difficult time answering: “What is a good gross profit margin?” The best method for determining a good gross profit margin involves comparing your percentages to sector averages (and alongside operating margin and net profit calculations) to identify ratios good for your business. What is Gross Profit Margin? Gross profit margin (sometimes referred to as “gross margin” or “gross margin ratio”) is one of the primary metrics used to evaluate a business’ health and competitiveness within its industry. Measured as a percentage, gross profit margin will tell you how much revenue your products and services generate per dollar after subtracting your cost of goods sold. Determining this ratio is most helpful for assessing individual goods and services. While gross profit margin remains an important metric for businesses to track, it gives an incomplete impression in isolation. Your company also must account for other operating expenses—such as other employee wages, facilities overhead, and taxes—that do not factor into calculating your gross profit margin. Trying to gain insight from gross profit margin alone is like declaring a jigsaw puzzle finished when you only have one-third of the pieces. Calculating Gross Profit Margin You still need the pieces provided by gross profit margin, though, to complete the picture. Thankfully, calculations are simple:
Gross Profit Margin = (Net Sales – COGS) / Net Sales or 30% = ($300,000 – $210,000) / $300,000 Industry Averages for Gross Profit Margins One of the difficulties in determining whether or not your business has achieved a good gross profit margin lies in how much variance occurs across different industries. While the overall average sits above 30%, there is a wide disparity in gross profit margins between regional banks (99.75%) and automotive businesses (9.04%), for example. Generally speaking, service industries that do not sell physical products will post higher gross profit margins because they have a much lower COGS. A lawyer or consultant will not have as many necessary expenses to meet when providing clients with their “goods.” In contrast, manufacturing and food vendors must factor in higher upfront costs for equipment and raw materials to deliver purchasers a finished product. Using your specific industry as a baseline will help determine whether your business has achieved a comparably good gross profit margin. Here are some averages for different sectors as of January 2021, along with their net profit margins (which will be explained further below):
*Total Market calculations include industries not shown. The Big Three: Gross Profit, Operating, and Net Profit Margins The significant fluctuation between gross profit margin and net profit margin shown within many industries demonstrates how gross profit margin only comprises part of the picture. To holistically evaluate your business’ financial health and competitiveness, you will have to assess additional metrics in conjunction with gross profit margin. Determining your operating and net profit margins will help complete portions of your puzzle
Operating Margin = (Net Sales – COGS – Operating Expenses) / Net Sales
Net Profit Margin = (Net Sales – COGS – Operating Expenses – Additional Gains or Losses) / Net Sales None of the three metrics provide enough information on their own to declare your business a success or concern. A company could post incredible gross profit margins but see most of those percentage points whittled away by remaining operational expenses. One year’s net profit margin could reveal itself as an outlier if the business posted a massive gain or loss by selling or purchasing a physical location. Collectively, however, you can look at all three margins to determine your business’ overall outlook. Using and Improving Gross Profit Margin Once you have determined your business’ gross profit and other margins, you can begin identifying areas to optimize your operations. As general gross profit guidelines, remember:
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