What is a Good Gross Profit Margin? Tips to Improve GPM and Drive Profitability

As the year ends, it’s essential to keep your business’s financial health top of mind. Whether you are running a small business or a large enterprise, the fourth quarter can be a make-or-break period for achieving your financial goals. The good news is there are several things you can do to ensure that your business ends the year on a high note.

As a CEO or business owner, you know that understanding your company’s financial health is crucial to success. One of the most important metrics for measuring this is the Gross Profit Margin (GPM). GPM provides insights into your company’s profitability and operational efficiency, making it a critical tool for business decision-making. By analyzing your GPM, you can identify areas where you may be overspending or undercharging and adjust your strategy accordingly.

Defining Gross Profit Margin

According to Small Business Chronicle , the formula to calculate GPM is as follows:

Gross profit = revenue – cost of goods sold

After you calculate gross profit, you can determine the gross profit margin using this calculation: Gross profit margin = (gross profit ÷ revenue) x 100

The GPM equation represents the percentage of revenue retained after deducting the direct costs associated with producing goods or services. It is calculated by  subtracting the cost of goods sold from total revenue and then dividing the result by total revenue.

In other words, as a percentage, a GPM will show how much revenue a company’s products and services make per dollar after subtracting your cost of goods sold.

Understanding a Good Gross Profit Margin

Now that you have the formula, you can start to assess and determine whether your company is meeting its fiscal goals for the year. If the gross margin fails to adequately cover the operating costs, it results in a negative net income, which is a scenario no company desires by year-end. Avoiding negative net income is a common objective for businesses.

Another perspective to evaluate the efficacy of Gross Profit Margin (GPM) involves reversing the formula. Consider a scenario where a company aims for $250,000 of net income for the year. Given the knowledge that operating expenses constitute approximately 40% of gross revenues, management can reverse-engineer to determine the requisite gross profit margin that aligns with this financial target.

Profit margin is an essential metric that measures the profitability of a business. A good margin varies by industry, but it’s crucial to aim for a margin that is above the industry average. As a rule of thumb, 5% is a low margin, 10% is a healthy margin, and 20% is a high margin. But a one-size-fits-all approach isn’t the best way to set goals for your business’s profitability. It’s important to note that profit margins can vary significantly within the same industry depending on factors such as the business model, product mix, and pricing strategy. Therefore, it is vital to compare your profit margin with other similar businesses in your industry to determine whether you’re on track or need to adjust to improve your profitability. Below are average profit margins by industry as of 2023.

Source: Polymer

Importance of Gross Profit Margins
There are several key takeaways as to the role GPM can play in your business:

1. Profitability Analysis
   GPM is a direct reflection of a company’s ability to generate profits from its core business activities. Owners can compare their GPM percentages over time to assess the success of their strategies and to ensure that production costs are managed effectively. Additionally, comparing margins with industry benchmarks provides valuable insights into a company’s competitive positioning and potential areas for profit optimization.
2. Decision-Making Confidence
   If you’re a business owner looking to launch new products or services, you should consider using gross profit margin to forecast potential profitability and to adjust your goals accordingly. By understanding your GPM, you’ll have a better understanding of how much you can charge for your products or services, and how much profit you can expect to make.  Additionally, comparing your GPM with those of your competitors can give you valuable insights into pricing strategies and help you stay competitive in the market. With this knowledge, you can make informed decisions about your business and take the necessary steps to maximize your profitability.
3. Financial Health Indicator
   Indeed, a declining margin may signify rising production costs or an inability to set the right price for customers. Owners can use GPM as an early warning sign to help proactively assess whether their price points and operations are working smoothly together.
4. Investor Confidence
   GPM is a crucial financial metric that investors use to evaluate a company’s profitability. It measures the percentage of revenue that remains after accounting for the cost of goods sold. A higher GPM indicates that a company is generating profits efficiently and has better financial stability. Investors often use GPM to assess a company’s long-term sustainability and potential for growth. As a shareholder, a higher GPM would translate to higher returns on investment. GPM is a crucial indicator of the profitability of any business. As we approach the end of the year, it’s essential to focus on this metric and ensure that your business is running as efficiently as possible. Here are four strategies that can help you boost your Gross Profit Margin over the next 45 days:
   1. Review your pricing strategy – Analyze your pricing strategy and identify areas where you can increase prices without losing customers.
   2. Improve your inventory management – Optimize your inventory management process to reduce waste and minimize the cost of carrying inventory.
   3. Streamline your operations – Identify any inefficiencies in your business processes and streamline them to reduce costs and increase productivity.
   4. Focus on higher-margin products – Evaluate your product mix and focus on selling higher-margin products that offer a better return on your investment.

Working with a B2B CFO^®
By engaging with a B2B CFO^®, your company benefits from the experience of a financial expert who provides a fresh perspective on your financials and can identify opportunities for improvement. B2B CFO^® Partners are dedicated to helping business owners achieve their growth potential by eliminating financial barriers.

With their proven expertise, they can analyze your company’s financial performance and create a customized plan to enhance it. By partnering with B2B CFO^®, you can streamline your financial operations, increase profitability, and achieve long-term success. For a complimentary consultation, please email me at PeggyHead@b2bcfo.com.

Learn more about how we help business owners thrive and sustain long-term financial health. Visit b2bcfo.com.