Last updated on December 8th, 2022
Finances is generally considered to be one of the most difficult parts of running a business due to all the math involved.
This is probably why 37% of businesses outsource their accounting to someone with a lot more experience in the field – but not every small business can afford to do that.
According to an UpCity poll, 23% of businesses said that high costs were the biggest challenge with outsourcing.
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What this means is that there are a lot of businesses out there that have no choice but to do their own calculations – and it’s super easy to make mistakes.
Here is my process for calculating gross profit margins. Hopefully, if you are having any trouble calculating your own for your e-commerce business, then this guide below will help you out!
What Are Gross Profit Margins?
Before I go into detail about calculations, I want to go through what exactly gross profit margins are to make sure we are all on the same page here.
Gross profit margin (sometimes also called gross profit ratio) is a type of metric used to evaluate the financial health of a company.
Basically, it works out how much money is left over from the sales after subtracting all of your costs of making the product. This will then tell you how much money your business has made.
What Is Gross Profit Margin Used For?
Gross profit margin is used to check how healthy a company is financially, acting as a kind of ‘pulse’ to highlight any issues that are affecting your business.
For example, if your company’s gross profit margins are constantly fluctuating up and down, then this could be a sign of issues like poor management, constant changes to its operations, or just bad products.
Flawed business models are behind 19% of business failures so keeping track of your gross profit margins can help businesses spot flaws because they cause any lasting damage.
From there, business owners can highlight issues and make changes to help improve their business.
They can also compare their gross profit margin to their competitors to further help them assess their own performance in comparison.
20% of businesses fail because they are outcompeted so gross profit margins are a great way to keep an eye on how your business is faring compared to your competitors.
Gross Profit Margin VS Net Profit Margin
One mistake I’ve seen a lot of first time e-commerce businesses make is mixing up gross profit margins with net profit margins.
The net profit margin is also a type of metric businesses use to check the financial health of their business but the key difference is that net profit margin includes the business’s expenses.
This means that gross profit margin focuses on how much it takes for your company to make a product and how much profit it makes once you take away the cost of making it.
Net profit margin includes all of your other finances, such as taxes and operation expenses, which can further eat into your profits.
Basically, gross profit margins do not give an overall picture of your business’s profitability because it doesn’t include all its ‘costs’.
Because of this, some argue that gross profit margins do not give an accurate representation of how profitable your business is and this can be misleading for some business owners.
However, I still think it’s worth calculating your gross profit margins as the more data you have, the better you can understand your business.
What Is A Good Gross Profit Margin For E-Commerce Businesses?
There is no definitive ‘good’ gross profit margin as every business is different, and so should its goals be when it comes to finances and profits.
Some articles give a very generalized ‘aim for 25%’ while other studies say 36% but these do not take into account multiple factors such as business size and industry.
Different businesses have different target gross profit margins. Even by having an e-commerce business, you should have a different profit margin goal to offline retailers in the same industry as you.
For example, the ‘good’ gross profit margin for a general retailer is 24.27% but for online retailers, it nearly doubles at 42.53%.
So, finding the ‘good’ gross profit margin your business should be aiming for can be very tricky because there’s a lot of variance from business to business.
The best thing I would recommend you do is talk to a financial advisor as they would have a better understanding of profit margins for your specific business and situation.
They should be able to give you a more precise goal in terms of gross profit margin and so, you should be able to have a better idea of where your business stands financially (see also, ‘What’s Driving the Growth of Fintech?‘).
How To Calculate Gross Profit Margin
Now, let’s move onto the real meat of this guide – how you actually calculate gross profit margin.
Gross profit margin is actually one of the easiest calculations involved in this part of running a business but you first need the right data (see also, ‘What is Data Scrubbing and How to Use it for Your Business?‘). Without it, you simply can’t calculate your gross profit margin.
First, you will need the numbers for your ecommerce (see also, ‘What is PDP in Ecommerce?‘) business’s gross profit. To calculate these, you will need your net sales revenue and cost of sales. Take your net sales revenue and from it, subtract the cost of sales like this:
Net Sales Revenue – Cost of Sales = Gross Profit
Then, divide your gross profit by your net sales revenue:
Gross Profit ፥ Net Sales Revenue
Multiply the result from this by 100% and this will give you your gross profit margin. Here is what the final formula looks like:
Gross Profit Margin = ((Net Sales Revenue – Cost of Sales) ፥ Sales Revenue) X 100%
The final formula may look a little scary, especially if you’re not that great with math and numbers, but trust me when I say that it’s super easy.
Getting the data is the hardest part but once you have it, you can calculate your gross profit margin in a matter of seconds.
Ways To Boost Your Gross Profit Margins
A lot of businesses are worried about cash and improving your gross profit margins can help put some of those concerns aside.
71% of small businesses admitted to inflation having a negative impact on their business, and cash flow was the top challenge in 2022 for 40% of businesses, with inflation and low sales also making the list.
Here are some ways ecommerce businesses can help increase their gross profit margins to improve that cash flow and help protect your business from inflation (see also ‘Best Monitoring Tools For eCommerce‘).
Reduce Your Costs
One thing that eats into profits is costs and by cutting back on them, you are saving yourself more money to widen those profit margins.
As a result, I recommend you take a look at things like:
- Labor costs
- Office costs
- Employee benefits
- Equipment Fees
- Maintenance Fees
Cutting back on the easy things will have an instant impact on your profit margins. However, don’t go too overboard – your business still needs to run!
Cutting back on employee benefits can also upset your employees and have an impact on productivity and employee retention.
78% of employees say they would stay with a company because of the benefits they received, so be wise with your cost cutting decisions.
Introduce A Customer Loyalty Program
Introducing a customer loyalty program can help improve your gross profit margins in many ways.
Firstly, 62% of consumers spend more money after signing up to a paid loyalty program, so using a customer loyalty program can help boost your sales. The more sales you make, the more profits you have to do what you like with.
Secondly, customer retention is super important and a loyalty program helps achieve higher retention rates.
Repeat customers spend around 67% more than a new customer, and 82% of companies agree that retaining customers is much less expensive than the cost it takes to acquire a new one.
So, a customer loyalty program can help you boost your sales while cutting back on marketing, widening those gross profit margins even more.
Raise Your Prices
I mentioned earlier how inflation is a big concern for businesses recently and it’s easy to see why. Inflation means that a business’s cost of sales will rise and their overall gross profit margin will shrink – unless they raise their prices in line with this inflation.
One study found that more US consumers are limiting their spending to combat inflation, focusing on necessities and switching to cheaper brands and products if they need to.
As an ecommerce business, you could be in two boats about this: you are seeing more orders because you offer a more affordable price than your competitors, meaning that if you raise your prices, you are likely to lose those orders.
On the other hand, raising your prices may also lose you the customers you currently have as they switch to a cheaper competitor.
The thing is, if you don’t raise your prices with inflation, you could end up losing money rather than making it – and that is not what any business owner wants.
So, calculating your gross profit margins is actually a lot easier than it may initially sound. I get that math can be scary for those who weren’t good at it in high school, but that shouldn’t hold you back from starting a successful business.
Businesses who can afford to outsource this kind of stuff usually do, and those who can’t may find that the most common calculations for businesses aren’t actually that difficult to do.
I hope this guide has helped you out and given you the confidence to pick up that calculator and start doing the math!