If you are a would-be small business owner you probably want to pay attention. Today I would like to define and discuss the Gross Margin Percentage (GM%). Basically, it is total sales minus cost of the total sales divided by the total sales times 100. It is the percentage of how much a business keeps out of every $1 of sales before costs of general operations are considered. So, with that definition it should be apparent that the higher the GM%, or amount kept from every $1 of sales, the better. Find me a business with a GM% close to 100% and I will show you a happy owner! If there is a business that has a negative GM% that is a business that is essentially running itself into the ground with each sale.
Continuing on, we know that the higher the percentage the better. However, the GM% varies by industry and by the size of the business. Pure service related businesses should have a GM% greater than 50% and some in the 90% range. Alternatively, manufacturing businesses can have a GM% of around 30% or so. The percentage drops the more materials and labor that is required to produce the product. A GM% comparison of a doctor’s office and a coffee shop is not a fair comparison.
Another variant is the size of the business will change the range of the GM% that a business owner can attain. Successful large businesses will naturally have a lower GM% than similar but smaller business in the same industry. This is because labor to produce a product or complete a service should be in the cost of the sale. As the business gets smaller the owner is most likely doing a lot of the work need to produce the product or complete the service. The compensation of the owner is usually the profit from the business, so their labor is free for this discussion and not included in the cost of the product. Therefore, the GM% should be higher for small businesses where the owner’s labor is free.
The gross profit percentage is one of the metrics that a business owner must use to evaluate before entering an industry and monitor closely when the business is operational. It is very important when planning to start a business to figure out how much you have to sell in order to cover your costs and break even. That is a discussion for a later time.