How to really measure how profitable you are

We are delighted to announce today our very first guest blog post from Jake Willott, a smart business owner who wanted to contribute to the Being Smarter community… Take it away Jake.

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Mark-up and Gross Margin are two different beasts

A clear understanding and application of the two within your pricing model will have a drastic impact on the bottom line.

Mark-up is the percentage difference between the actual cost and the selling price

£90 x 25% = £112.25

Gross margin (or gross margin) is the percentage difference between the selling price and the profit. Profit/Sales Price.

£22.50/£112.50 = 20%

These two definitions are extremely important because gross margin directly tells us how many of our £’s from sales are profit.

It is easy to make the mistake in thinking that if a product is marked up by 25%, the result will be a 25% gross margin on the income statement. However, a 25% mark-up rate produces a gross margin percentage of only 20%. By targeting the gross margin percentage vs the mark-up percentage, businesses in general can add an additional 5% profit to the bottom line.

A worked example:

If you increased the selling price of a product by 5% the figures then look like:

Buy at £90 sell at £120. £30 profit (or 25% gross margin)

Increase sale price by 5%. £120 x 1.05 = £126

The cost to us remains the same so the gross profit is now £36 and gross margin is 28.5%.

So the gross margin has gone up by 3.5%, which as a percentage of the starting 25% is an increase of 14%

So for a 5% increase on the selling price we’ve gained a 14% increase in gross margin.

Even better, let’s look at the cash profit. You were making £30 on the sale, now you’re making £36 – an extra £6. As a proportion of our initial £30, that’s a 20% increase.

A 20% increase in cash for a 5% increase in sale price.

The reason this happens (if you’re still here) is that any improvement in gross margin % is multiplied by the turnover.

In summary:

Figure out who your most profitable customers are, and we can only know that if we measure using the correct metrics.

And a small change in selling price has a large effect on increasing profit.

Jake Willott is the MD of Computer Medicine
The computer people who come to you
www.computermedicine.co.uk