Gross Margins versus Sales

It is easy lose sight of the difference between margins and sales.  Many businesses talk in terms of the sales they make.  But the figure you should really be interested in is the volume of Gross Profits your business delivers.

The Gross Profit Margin you make over the cost of providing a product or service (the Cost of Sales) is the money left to contribute to pay overheads (relatively fixed), and then when you have covered those, becomes your profits.  

I want to touch upon two examples where it is easy to get confused by the impact of the Sales you generate, versus Gross Margins they return.  I’ll talk about breakeven another time

These examples relate to:

•    Bad debts, and

•    Promotional campaigns.

Let’s take bad debts first. 

Of course, this does not apply to you if you get cash payments on delivery, or better still, payment before delivery.  However, a significant proportion of small businesses invoice their clients on delivery of the product of the service. 

Your Terms of Trade may vary anywhere between 7 days to 6o days.  I’m talking about when you require payment, not when you actually get paid.  Unfortunately, we often find that the bigger the client, the slower the payment. 

What happens when you have a bad debt?

Say your sale was $1,000 and your Gross Margin was 35% ($350).  The sale goes bad for whatever reason, and the client does not pay.  It is easy to assumethat you all you have to do is make another sale of $1,000 to recover your position. 

Easy to assume, but wrong!

To recover that $1,000, you have to make enough profit to get the sales value back, because a significant proportion of the new sale will be, as before, the Cost of Sales – the cost of providing goods or service. 

And that amount we can calculate by dividing the sales figure ($1,000) by the Gross Margin (35%).  And that gives the princely sum of $2,857, and that’s without the cost and effort of achieving the new sale.

It makes sense to set yourself up so that this situation does not arise.   Policies and procedures help, as does getting paid up front, or at least a reasonable down payment.  In these days of multiple credit cards, securing a credit card imprint can be useful.  In other words, get the client or someone else to cover the debt. 

You are not in the banking business.

And so to promotional campaigns. 

Much the same situation applies, except that it is harder to measure.

If you do decide to calculate return on a marketing campaign: when comparing cost to returns, "returns" should be your profit, not your gross sales. If you spend $1,000 on a marketing effort and generate $1,000 in sales, you are losing money; you are out the direct cost of product or services that you sold for $1,000.  And you have no contribution to other overheads.

You have only broken even on a marketing campaign that costs $1,000 when you have sold enough product or services to generate a $1,000 PROFIT.  How much sales that requires depends completely on your products, and your profit margin.

There is a further complication!

Your business will undoubtedly have a number of product/service lines.  I’m sure you know the sales each generates, but do you know their profitability?  In nearly thirty years of working with small businesses, the biggest problem I’ve found hindering their prosperity and growth is not knowing what is going on in their business, where the money was being made, or lost. 

What hinders, and what helps?

So often the profitability of one or two lines is masking the lack of profitability of others.

Here are a couple of articles you might find useful.

  • https://profitsleakdetective.com/articles/32-dont-increase-sales-increase-gross-profits
  • https://profitsleakdetective.com/articles/65-what-is-break-even-and-why-is-it-so-important

Are you inflicting failure on your business?

When clients approach me for coaching, clients with businesses that are underperforming despite the crippling hours and effort the owner is putting into them, they are sometimes held back by lack of knowledge of what is happening in their business. 

A lack of focus of potential improvements leads to a lack of control over their business, and eight times out of ten that lack of control comes down to a lack of knowledge of what is happening in the business, and what their peers are achieving.

For more than 29 years I’ve been helping small business owners plug the profit leaks in their business and restoring their cash flows by assisting them understand where and how they may change their business to be a leader in profitability, productivity, and competitive advantage. 

If you would like to discuss with me how you might do that, book a Strategy Consult here



© Copyright 2018 Adam Gordon, The Profits Leak Detective

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