When you run a small business, knowing your general levels of profitability before accounting for expenses, called your gross margin, can give you a competitive edge. Knowing your gross margin helps you make informed decisions about the future of your company, such as cutting labour costs, raising prices, or taking on new suppliers.
Calculating Gross Margin
To calculate your company’s gross margin:
- Subtract the cost of goods you sold, or COGS, from your total revenue
- Divide the result, or your gross profits, by your total revenue
- Multiply the result by 100 to determine your percentage
For example, imagine your e-commerce business imports items that cost $100,000 and sells those items for total revenue of $200,000. Your total revenue minus COGS ($200,000 minus $100,000) gives you your gross profits ($100,000). Divide the $100,000 by the total revenue of $200,000 to arrive at 0.5, which you then multiply by 100 for a gross margin of 50 percent. This means that your business retains 50 cents from every dollar of revenue it generates.
Tracking Your Gross Margin
By keeping track of your gross margin monthly, bi-weekly, or even weekly, you can see how your business is trending and determine if you need to make adjustments. Average gross profit margins vary by industry. For example, car dealers see an average gross margin of approximately 14%, because the cost of goods is so high and the businesses typically carry a lot of inventory. The legal services industry enjoys an average gross margin of 93%, as production costs are low and revenue runs high. When you compare your gross margin to industry averages and your business’s history, you can determine what changes, if any, you need to make. If you see a decline or you’re far below the average, it may be time to cut labour or supply costs. You may also review strategies to boost revenue.
E-Commerce Gross Margins
E-commerce businesses tend to have lots of scalability, which just means that your operating costs don’t go up much as your company grows. Because you don’t need a huge physical presence, you can keep more of every dollar you spend by avoiding rent on warehouses. In many instances, e-commerce profit margins remain high because the small business owners who run them do so from their own homes. Due to these factors, you can often grow your e-commerce business at a faster rate than old-school wholesalers and manufacturers.
The Importance of High Gross Margins
Businesses with higher gross margins tend to survive and thrive better than those with lower percentages. This metric can impact your income statement greatly, especially when it comes to net profit. This, in turn, makes it important to keep track of your gross margin for the same reason your e-commerce business has an edge over brick-and-mortar endeavors. Because how much your goods cost and how much you take affect your small business outcomes the most, low margins mark a failure to thrive, which can leave you flat if you encounter unexpected expenses.
If your e-commerce business falls below a gross margin of 20 to 30 percent, it could indicate that you have issues you need to address. Knowing this ahead of time lets you adjust your pricing or search out sources for cheaper goods.
Gross margins can have a big effect on your bottom line, even more so when you operate an e-commerce business. This makes tracking your gross margins on a regular basis vital to the health of your company, and accounting software with reporting features helps you streamline the process. Keep your books accurate and up to date automatically. Change the way you manage your finances now.