Gross Profit Margin is the percentage of money you have left after you pay all the costs of producing the goods and services you sell. I work primarily with service industries (businesses that provide specialized skill technicians or workers to complete a job, with goods being secondary to that service), rather than retail (goods are what is being sold and specialized skills are not required per se). So, this article will deal with GPM as it applies to service industry.
There are three primary elements to figuring out what your accurate gross profit margin is:
- Gross Sales – not including sales tax or mandatory governmental fees that you will have to pay out (such as disposal fees, hazardous waste fees, etc.), what were your total sales? I consider sales on the day they are invoiced, rather than the day are paid (i.e., if you have accounts that pay within 30 days).
- Cost of Goods Sold/Cost of Parts – this is what it cost YOU for the parts or goods needed to perform the services sold as part of those gross sales.
- Cost of Labor/Cost of Production – this is what it cost you to employ the specialized technicians or workers that actually did the service that is included in the gross sales.
- NOTE THAT I DID NOT SAY HOW MUCH YOU PAID THEM… The cost to employ someone is much more than their actual pay. When I calculate the cost of labor, I include a % that covers all the additional things we forget are part of employing someone – FICA/MED match, FUTA, SUTA, Worker’s Comp, Vacation Pay, Holiday Pay, Insurance, Uniforms, etc.
- NOTE THAT I DID NOT INCLUDE NON-TECH EMPLOYEES HERE. This does not include your book keeper, sales force, customer service/receptionist. This only includes the employees that are actually doing the service work itself.
After you have this information collected, you can calculate your gross profit by simply subtracting your Cost of Goods Sold and Cost of Labor from your Gross Sales.
Your Gross Profit Margin is the percentage that $ represents – is your GPM 50%? 20%? What is your industry’s benchmark for success? Most service industries have well established guidelines for these numbers to predict whether you will be successful and able to sustain that success. If your numbers fall well below those benchmarks, it is a sign that your pricing is probably way too low – if you are not already struggling to meet expenses, you will soon.
Remember, GROSS PROFIT is not NET PROFIT. You still haven’t paid your rent/mortgage, the electric bill, the phone bill, that receptionist, that sales clerk, etc. And you haven’t paid yourself. So, don’t spend this money just yet…