If it’s Gross it must be good

by Malcolm Simister

When my kids used to say that something was gross they meant it was bad (‘Ugh, that’s gross’) but in business Gross must be good – Gross Profit I mean.

Gross Profit is one of the most important numbers in Income Statements (Profit & Loss Accounts) and many business decisions are taken to improve it. These decisions are not made by accountants but by marketers, sales people, buyers, engineers, supply chain managers and others. Gross must be good if the business’s overall profit is to be good, so how do you know if yours is good?

The only true way is to compare your business’s Gross Margin (that’s Gross Profit as a percentage of Sales Revenue) with the best in the industry, internationally. If your business is the best in the industry, don’t be complacent as the others will be trying to catch up!

So, how do you make Gross good or even better? Broadly, either increase Sales Revenue or decrease Direct Costs (the costs directly incurred in producing the products sold such as people costs, materials/goods and direct overheads) or a combination of the two.

If Sales Revenue is too low it could be that product prices are too low or, conversely, they might be too high resulting in low sales volumes (Gross Margin on each product sold would be high but because of low volumes total Gross Profit would be low).

If Direct Costs are too high is it because supplier prices are excessive, production efficiency is sub-par, products are of poor quality leading to excessive rework or for other reasons? Analysis of the Income Statement and drilling down to further detail can pinpoint the reasons and then the managers can decide what to do about it.

The trail to these business decisions starts with Gross Profit and Gross Margin. The Income Statement tells the story, you just have to know how to read, interpret and use it which nowadays as never before are essential skills for all business managers and company directors.

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