Your business might be selling products and increasing revenue. But that doesn’t necessarily mean you’re making money.
Gross profit is a very important metric for every company to understand because it’s a key indicator of whether or not you’re able to produce your product or service with high enough margins to make money.
Let’s dive into the in’s and out’s of gross profit, including the formula, why it’s important, and how to improve yours.
Table of Contents
- What is Gross Profit?
- How to Calculate Gross Profit
- Why Gross Profit is Important
- How to Increase Gross Profit
What is Gross Profit?
Gross profit is a company’s earnings after deducting the Cost of Goods Sold (COGS). In other words, it’s your retained revenue after incurring the total cost it takes to produce and sell your product or service. However, gross profit doesn’t account for your operational expenses.
Gross profit will typically be reflected on a company’s income statement. Here’s what it looks like in Finmark’s Profit & Loss report.
How to Calculate Gross Profit
To calculate gross profit, you subtract your COGS from the total revenue.
Gross Profit Formula
Total Revenue – COGS = Gross Profit
For example, if your business brought in $10,000 and your COGS is $3,000, then your gross profit is $7,000.
Note: while gross profit is expressed as a monetary value, there is a similar metric — gross margin — that is expressed as a percentage. Gross profit margin helps business owners to understand efficiencies over time and are key indicators of how well you are managing resources.
But why is gross profit important? Lucky for you, we will dive into that in the next section of the guide.
Why Gross Profit is Important
Similarly to gross margin, gross profit helps you understand how efficiently you’re producing your product or service. It also gives you guidance on how much you can afford to spend on operating expenses to grow your business.
If you are spending more than you are bringing in, then this is a major red flag for your business. Not having enough—or any—profit will mean that your business has no opportunity to grow.
For startup founders, finding ways to increase growth and profit while minimizing expenses is of utmost importance, as money in the bank can be the difference between failure and success in the early stages of your business.
Measuring and understanding gross profit can also help in planning for future growth. Up-to-date revenue and expenses can help to project future growth and forecasted margins to plan for budgets, new products, additional team members and more.
Real-time, accurate financial models are the key to measuring gross profit and planning for growth.
How to Increase Gross Profit
While many think that increasing gross profit comes down to selling more products, it actually has more to do with lowering production and supply costs than selling alone.
Yes, if you sell more then you’ll make more. However, if it also costs a significant amount of capital to continuously produce your product or service, then you’ll be stuck in a vicious cycle without any opportunity to truly make money.
Consider the following tips to help reduce production costs and increase your gross profit:
If you’re a small-scale consumer goods provider, then you may not have a ton of wiggle room to increase prices. However, for SaaS companies, you have more opportunities to increase prices, as people will pay more for software than you may think.
You could increase prices based on product usage, the number of seats/users an account has, or based upon the annual contract. Many contracts lock in a 3-5% increase in prices annually, and depending on your product, many won’t blink an eye before agreeing to the increase.
Minimize Discounts & Offers
We get it. Offering discounts during the sales process makes it a lot easier to get a potential customer to sign on the dotted line. However, making this a standard practice will ultimately hurt your business in the long run.
Save discounts and other offers for the select few — customers on the verge of leaving or large prospects who may spend more on cross-selling and up-selling once they are a customer.
Increase Your Average Order Value
Speaking of cross-selling and up-selling, increasing the average value for a typical order is another great way to increase your gross profit.
For subscription/SaaS companies, this could be through add-ons, cross-selling, and selling higher-priced plans. Add-ons can include professional service hours to get the implementation up and running, additional seats to account for new team members that will be using your product, or additional features or services that drive up the order cost.
Review & Cut Unnecessary Expenses
There’s more that goes into creating your product or service than you may think. But is it all necessary to the product itself?
Eliminating unnecessary expenses or negotiating with vendors to lower outsourced costs — from suppliers to overseas engineering talent — can help to reduce your COGS, and in turn, increase your gross profit.
Start Measuring Gross Profit Today
See? There’s ample opportunity to reach that business gold standard and net out a profit.
One of the best places to start is by having a strong financial foundation. Finmark can help.
Start your 30-day trial and say goodbye to confusing canned financial models and hello to accurate, customized financial models that truly reflect your business.