I talked about the profit and loss statement in an earlier post, but wanted to tackle gross margin today.
What is Gross Margin?
Gross margin is a part of the P&L statement and if you’re in sales it’s important to understand for both YOU and YOUR customers and prospects.
Simply put, gross margin is the difference between the revenue a product or service creates and the cost of creating that product or service. In other words, if it costs a 10 dollars to create a widget and the widget is sold for 15 dollars, the gross margin is 5 dollars or a 33% gross margin percentage. The higher the gross margin the better the business. Higher gross margin means there is more money left for operating the business and for doing other things. When gross margin is tight, it’s difficult to run the businesses as there is very little money left over for operations. When margins are low, heavy sales volume is required to maintain the business.
A lot of things can go into the expense side of gross margin. Some companies like to load this part of the P&L up. Others try to keep it low only including the direct costs of the product and omitting labor. The expenses that go into gross margin are called cost of goods and include the parts that go into the product, the direct labor costs, materials, etc. The key here is to keep cost of goods expenses as low as possible.
Remember, gross margin is the difference between the revenue generated by a product and what it costs to make the product.
Formula for Gross Margin
Revenue – Cost of Goods =Gross Profit
Gross Profit / Revenue = Gross Margin
The other way to improve or affect gross margin is to increase revenue. If the cost of goods are high, then increasing your prices can help strengthen gross margin. Whether you chose to focus on value so you can increase your prices or focus productivity to improve costs, either way it’s critical to have as much a spread (gross margin) as possible.
As a salesperson understanding your customers gross margin can be a huge asset. The higher it is the more money your customers and prospects have to invest in sales, marketing, people, infrastructure and more. The majority of the things companies buy DON’T fall into cost of goods, they are operating expenses, which means what you are selling is highly influenced by how strong your customers gross margin is.
Understand gross margin, where you can. Try to know what your customers gross margin is. It can be helpful tool in the sales process.
WITCE – (What is the Customer Experience) Questions:
- What is your customers gross margin?
- How does your product or service affect gross margin?
- Is there a way you can position your product or service to improve revenue or cost of goods?
- Is your customer below or above the industry average for gross margin?
- What happens if gross margin starts to shrink, is your product or service first to go or are you in the critical path?
Gross margin isn’t a panacea to sales, but it’s a great little metric to understand and to evaluate when possible. It’s a critical to the health of business, so why not know how it works?