Gross Profit = Sales Revenue - Cost of Goods SoldIn order to understand gross profit, you have to understand fixed and variable costs. Variable costs are those that the company incurs as a result of producing its product. They are, essentially, cost of goods sold. So, the gross profit equation can be restated as:
Gross Profit = Sales Revenue - Variable Costs
Gross profit is expressed on the income statement as a dollar amount. Gross profit margin is expressed as a percentage:
Gross Profit/Sales Revenue = Gross Profit Margin ______%
Gross profit is what you have left over after you pay all your variable costs or costs associated with producing your product or service. It is important to track the gross profit margin in order to track profitability.
How to Increase Your Gross Profit Margin
Small business owners are always looking to improve their gross profit margins. In other words, they want to decrease their cost of goods sold or variable costs while increasing their sales revenues. Typically, there are two ways to do this.
First, you can increase the price of your product. You have to be careful about doing this, particularly in a poor business climate. If you make a mistake and increase your prices too much, your sales can drop. In order to increase your prices successfully, you have to gauge the economic environment, your competition, and the supply and demand for your product, along with your customer base.
Second, you can decrease the cost of making your product or your variable costs. This is just as tricky as increasing the price of your product. You can make the product more efficiently. This might involve decreasing your labor costs. That may involve layoffs or otherwise impacting employee goodwill. If you decrease your labor costs in this way, it could affect the quality of your product.
You can also decrease your manufacturing costs with regard to materials. You may want to try to find a supplier for materials that offers them at a less expensive price. You can also try to negotiate volume discounts with your current supplier. If you buy materials in bulk, the supplier may give you a discount. When you are looking for a supplier offering materials for a cheaper price, never lose sight of quality. You don't want to compromise the quality of your product.