Young Woman Calculating Gross Profit Margin

Keep Tabs on Your Business’s Financial Health With Gross Profit Margin

4 min read • Dec 15, 2020 • Grant Olsen

If you have a business, you have a gross profit margin—it exists whether you bother to calculate it or not. But the more you know about your gross profit margin, the more you can use it to measure your performance and strategize for the future.

Your gross profit margin is a ratio that takes into account all the costs associated with selling your products or services (aka the cost of goods sold). It allows you to see what percentage of your revenue actually translated into profit.

If your profit margin were 35%, you’d probably be doing celebratory cartwheels around the room right now. If it were 3.5%, you’d likely want to investigate further. This metric is all about how efficiently your business can deliver products or services to customers. As you take steps to increase your gross profit margin, these improvements will also benefit the overall experience that customers have with your business.

“The customer experience on the outside is shaped by what is happening on the inside,” explains a business efficiency report from Forbes. “Internal efficiencies in the form of smoother internal processes and procedures translates into external customer experience improvements. To create a great external customer experience, the best solution is often to focus on internal efficiencies…Operational efficiencies run the gamut of ways to make processes run smoothly, and when done correctly can have a tangible impact on the business. Especially with the growth of new technology and automation, companies can run more efficiently than ever before.”

Efficiency is an ecosystem where every positive step taken has a cascading effect on your business. And metrics like gross profit margin are the best way to gauge where your business currently stands and map out where you’d like it to go.

Business metrics can sometimes get complex, but the good news is that this one’s pretty straightforward. Here’s how to calculate the gross profit margin for your small business:

 

Gross Profit ÷ Total Revenue = Gross Profit Margin

 

While the resulting metric is extremely beneficial for determining process improvements within your own business, it also helps you to assess competitors and learn from your industry at large. Companies don’t always release their gross profit margins for all the world to see, but you can track down the data if you know where to look. The best source: the industry reports created by financial data experts, such as ratings agencies or equity research analysts.

Most likely, you’ll find competitors with better gross profit margins than your business has. This is nothing to pout about—instead, sleuth around to find out what enables these businesses to manufacture their products or sell their services so effectively. You’re not trying to replicate their model—you’re striving to learn about other tactics that could potentially be applied to your business.

Your industry research will inevitably consider more than merely gross profit margin. You’ll want to analyze the full picture of your competitors, allowing you to improve your processes and other aspects of your business such as marketing and customer service.

“It is important to conduct routine competitor analyses throughout the lifecycle of your business to stay up-to-date with market trends and product offerings,” says small business guru Skye Schooley. “A competitor analysis can reveal pertinent information about market saturation, business opportunities, and industry best practices. It is also important to know how your customers view you in comparison to your competition. A competitor analysis will give you a better idea of what services are currently available to your target customer and what areas are being neglected.”

According to the Small Business Administration, there are 6 key factors to consider as you analyze your competitors:

  1. Market share
  2. Strengths and weaknesses
  3. Your window of opportunity for entering the market
  4. The importance of your target market to your competitors
  5. Barriers that could hinder your entrance to the market
  6. Indirect or secondary competitors who could hinder your success

As mentioned earlier, there will be plenty to learn from your competitors—but it’s not all about chasing taillights. Find ways to learn from their successes, but also take careful note of their limitations. Identifying weaknesses and unmet customer needs in your industry is a crucial way to carve out your distinct role.

Most of the research you conduct for your business should focus on how to get your product or service from the drawing board to customers in the most effective and compelling way. Gross profit margin is a critical component of tracking that journey. By paying closer attention to your processes, you’ll be able to leverage your strengths and find solutions for your weaknesses.

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Grant Olsen

Grant Olsen is a writer specializing in small business loans, leadership skills, and growth strategies. He is a contributing writer for KSL 5 TV, where his articles have generated more than 6 million page views, and has been featured on FitSmallBusiness.com and ModernHealthcare.com. Grant is also the author of the book "Rhino Trouble." He has a B.A. in English from Brigham Young University.