There are a number of ways to measure profitability for your SME.
- Gross Profit Percentage
- Operating Profit Margin
- Net Profit Percentage
Each will have their own purpose and relevance.
As we look at each ratios/calculations we will consider:
- What is it?
- Why it matters?
- Who cares?
Let’s firstly consider Gross Profit Percentage.
Growth Profit Percentage
What is a Gross Profit Margin?
The gross profit margin (GPM) is the percentage of sales revenue that is left once the cost of sales has been paid. It tells a business how much gross profit is made for every pound of sales revenue.
Formula for Growth Profit Margin
The importance of calculating Gross Profit
The gross profit margin is a fundamental indicator in the form of a percentage that highlights the businesses ability to manage efficiently its direct costs. A strong gross profit margin evidences a good business model and even where material costs increase these can be passed onto customers to maintain that margin. Where this isn’t possible due to poor market position, poor costing or lack of customer loyalty this margin will reduce and may highlight a struggling sales function.
Comparing and analysing gross profit margins over time can be useful to determine purchasing practice, looking at bulk discounts, material wastage, and the breakdown of product by business unit, geography and seasonality to see where efficiencies can be improved.
The longevity of a business often depends on its ability to maintain a healthy GPM, which will vary from sector to sector, from manufacturing to the service industry for example. The former, generally speaking will create more added value and attract a higher margin if costed correctly. The management team of a business would be keenly interested in keeping an eye on the gross profit to ensure procurement and pricing are done correctly and generating more cash from its core activities to cover overheads.