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Profitability: When Is It Good To Be Gross?

"Gross," definition; Very obvious and unacceptable behavior. Synonyms: uncivilized, uncultured, unpolished.

Most of the time it may not be great to be gross, but profitability is not one of them. You want to be as gross as possible! 

In measuring profitability, there are three levels that you need to look at:
1. Revenue minus direct expenses =  Gross profit.
2. Gross profit minus indirect expenses = Operating profit. 
3. Operating profit minus other income and expense =  Net profit.

By far the most important of these is level one. In fact I would go so far as to say that measuring your gross profit and your gross profit margin (gross profit divided by revenue) are the most important things for you to focus on. It is what I call the front line of winning the profitability war. If you lose the battle here, you have pretty much lost the war.

Despite how important this is, it is my experience that the gross profit level of profitability is almost universally ignored, and in some service businesses the gross profit is not calculated at all. The reason for this grievous error is that direct expenses are often called "cost of goods sold" and since a service business does not sell "goods" they deduce that they do not have a gross profit. They do but they never look at it and worse, they have no idea what it shouldbe.

I wish that this lack of focus was limited to service businesses, but it is not. In 30 plus years of talking to business owners, I have yet to have one tell me what they feel their gross profit margin should be for their business, and when it declines they usually fail to determine the reason and take corrective action. The result is a significant decline in the net profit margin.

Example: gross profit drops from 35.8% to 35.0%, a drop of 0.8%. If the net profit margin was 4.0% it drops to 3.2%. In other words a drop of 0.8% at the gross profit margin level causes a drop in the net profit of 20.0%!! (do the math if you don't believe me). Your goal should be to constantly measure your grossprofit margin and determine the reason for a drop of even one tenth of one percent. Then take corrective action if possible.

Click on the following link to read chapter two of the 60 Minute CFO book which contains all you need to know about measuring the three levels of profitability.

Measuring profitability

Now go to click here and download Business Mastery (Move Mastery for M&S companies) which will calculate your gross profit margin (and several others) for you every month. It's very good software and it's free!

And remember: at least sometimes it's great to be gross!!

Tracy Bech