Wanna Hear Something Gross???

Here are some gross realities about starting your own business and keeping it growing.

Ok, the title was a bit of social engineering to get you to read the article. Maybe the photo too. If it was successful, what's wrong with you? If you didn't already see through the ruse, we are talking about one of my favorite subjects, gross profit margin. Your gross margin is the Rodney Dangerfield of business metrics; it gets no respect. Revenue is so much flashier! Everyone wants to know how much they brought in and how much they sold. People brag on social media about how much they brought in this month with their business. All while taking pictures next to other people's cars to look successful. Just saw one in front of a Lamborghini that was literally at a stop sign (I kid you not. Tell me how that is his car?). They brag about revenue (also called gross receipts) while their business bleeds money because they are measuring the wrong thing.

Gross margin is pretty simple. It's basically the price of your product or service, minus the cost of labor and material to produce it, or the cost to buy it if you are reselling. For example, if you sell an item for $100 and you buy it for $70, you would have a 30% gross profit margin. You see how unsexy this number is? When people ask how much your business is making, you don't want to do math. But here's why it's so important. Your business runs on gross margin (I borrowed this statement from Dawn Fotopulos and you should check her out for more info on gross margin). Gross margin should be calculated for each product or service that you offer and it determines how much each sale contributes to your business. That contribution does two really important things; it makes you solvent and profitable. Solvent as in able to pay your bills and profitable as in you get money to put in your pocket at the end of the month, after said bill paying.

Trying to drive sales when you have too small of a gross margin is like trying to dig yourself out of a hole. Selling more doesn't help if each sale makes no contribution or, worse yet, a negative contribution. If you are math averse, don't worry, you've already done the uphill math. Here's the downhill math. How many sales do you have to make to pay the rent? Payroll? Your goal income for yourself? All you you have to do is divide by the gross contribution margin of your products to see how many you need to sell to cover each of these items. You can increase your margin by lowering the cost of goods that you pay or by raising the selling price.

How about the service businesses? Tons of small businesses are popping up in services. You may not, technically, have a cost of goods, because you have no goods. Your time and expertise is your product. First, this is a very good thing. You have the potential for a much higher margin, which makes surviving and thriving easier. Second, try this: factor in all the time it takes you to offer your service. Include the time you spend actually performing the service, the time you spend planning and organizing beforehand, and the time you average coordinating and communicating with the customer. If it's just you and you have no employee "labor" multiply that time commitment by a reasonable living wage rate and call it part of the cost of your service. Now build your packages and price your service accordingly. What you've just done is built a cushion that will provide you with a basic paycheck for the time you spend in each job, even before there is any "profit" left over. You are the business owner and the hired help, so why not realize how much you are being paid for those separate roles.

Comments
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BrianF
BrianF

Editor

This is great! So many people overlook this and it destroys their business. The distinction between these two is so important and needs to be done at the very beginning of creating a product or service. Knowing this is the difference between success and failure.

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