A Complete Guide to Gross Profit Margins

the relationship between gross profit margin and overhead
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Everything You Need to Know About Gross Profit Margins

Before you dive into your bookkeeping software and get to work tracking overhead costs, it’s important to know just what exactly you’re tracking and why.

The gross profit margin is important for businesses to track because it explains how well your costs are generating revenue.

In simpler terms, the gross profit margin helps you understand how efficiently your business is managing its money.

How To Calculate Gross Profit Margins

Your bookkeeping system should give you all the information you need to calculate your company’s gross profit margin.

All you need to do is to follow this simple formula:

Gross Profit Margin = Revenue – Cost of Goods Sold/Revenue x 100

The formula is very easy to use as long as you know which expenses to pull out from your bookkeeping spreadsheet and plug into the formula.

When calculating your total costs of goods sold, you will need to take a look at several elements.

Direct materials, direct labor, equipment costs that are associated with production, facility utilities, and shipping costs are all important costs to look out for when calculating your gross profit margin.

Using a cloud-based bookkeeping software keeps your costs and revenue easy to identify and makes calculating your gross profit margin much easier!

How to Understand a Gross Profit Margin

So you’ve gathered your cost of goods sold, identified your revenue, and plugged everything into the formula to get your gross profit margin. Good work!

The next step is to put that number to use. The easiest and most clear way to understand the gross profit margin is to use a trend line.

Look at the trend of your gross profit margin on a month-to-month basis using a trendline to identify strengths and weaknesses in your business.

Keep an eye out for declines in your gross profit margin percentage, because it can indicate that your company has lost its competitiveness.

Is Net Profit Margin the Same Thing?

There are several terms that get thrown around a lot when you’re dealing with business professionals.

One of those terms is “net profit margin”. Be careful, however, not to confuse this term with gross profit margin as they are not the same thing!

Unlike a gross profit margin, the net margin includes all expenses and not just the costs of goods sold.

In this case, administrative fees, selling fees, and financing expenses need to be added into the equation.

The net margin is great if you are looking to identify how profitable an entity is overall.

Overhead Costs & Gross Profit Margins

When looking through your bookkeeping system you may notice a significant number of overhead costs. So how do these tie into the gross profit margin?

Overhead costs are any costs that include ongoing business expenses. You will need to understand which of these to include when calculating your profit margin.

The overhead costs to keep an eye out for are manufacturing costs. These can include factory utilities and any indirect costs that come with producing goods.

On the other hand, non-manufacturing overhead costs are considered to be administrative costs. As we learned a minute ago, these would be included in calculating the net profit margin but not the gross profit margin.

If you’re still struggling to understand these terms and how they affect you, it’s time to invest in a cloud-based bookkeeping software. Arrow Cloud offers solutions to get your expenses and costs under control and easily understood. Give us a call today!

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