One of the most important metrics you need to track for your business is your gross profit margin. Gross profit margin shows the percentage of revenue left over after you account for the cost of goods sold. This figure doesn’t take into account other expenses such as payroll, rent, and utilities.
To calculate gross profit margin, you divide gross profit by sales. Then, you multiply the result by 100 to turn it into a percentage. That said, to do this calculation, you first need to find out your gross profit.
Gross profit is sales minus cost of goods sold. Cost of goods sold includes all the expenses directly related to creating or acquiring the goods you sell. If you have a shop where you purchase inventory, you count the funds you spend buying and shipping inventory. If you manufacture your own goods, you should take into account the cost of materials, direct labour, packaging, machinery, and warehouse expenses.
To give you an example with very simple numbers, let’s say you spend Rs.200 per month creating products that’s your cost of goods sold. Then, you collect Rs. 500 per month in revenue. When you subtract your cost of goods sold from your sales (revenue), the result is Rs.300. Then, if you divide that number by your revenue, the equation is Rs 300 / Rs. 500 = 0.6. Finally, multiply 0.6 by 100, and you get your gross profit margin of 60%.
You can use this margin to make projections about your company’s financials. For instance, if you estimate that you’re going to collect Rs. 600 in revenue next month, you can multiply that by your current gross profit margin (Rs.600 x 60% = ?360). Then, you know that you’re likely to have Rs. 360 left for costs such as payroll, marketing, rent, and utilities. You can also work on reducing some of your costs to increase your gross profit margin, and you can track the margin over time to see if your business is becoming more profitable.
While it’s possible to calculate gross profit margin on your own, you may want to find software that can help. Cloud-based accounting software such as QuickBooks Online can help you track the numbers and calculate gross profit margin as well as other metrics.