Strategy Session

Gross Profit vs Gross Profit Margin

gross profit gross profit margin revenue scaling variable cost Jul 14, 2022

So one of the questions that comes up is, what is gross profit and gross profit margin?

Are they the same thing or are they different?

And we've talked about gross profit, gross profit being the difference between revenue and the cost of delivering that revenue. So, revenue minus variable costs equals gross profit. What Gross profit margin is, is actually the percentage of that gross profit compared to revenue and I'll explain why that's important right after I give you an example.

So an example being we've got $1,000 in revenue, $300 of cost to deliver that revenue gives us $700 in profit. Now, our gross profit margin is 70%. That's $700 divided by 1000 is 70%. So, why is that number important? And I feel personally that this is probably the most significant number that we need to track in our business and for every dollar that we're generating in new revenue, we're profiting 70%.

So why is that important one more time, revenue minus variable cost equals gross profit less all of our fixed expenses equals our bottom line income. In our example, $1,000 less, $300 of variable costs equals gross profit of 700. If our fixed expenses are $400, we're making $300 bottom line income. If we were to change that to $2,000 of revenue, our cost of goods sold or our variable expenses go up from 300 to 600. That gives us still 1400 dollars profit and it's still 70% gross profit margin that number hasn't changed. But now when we take that number less, our fixed expenses, our profitability or our bottom line income has gone up substantially.

Why?

Because we've continued to increase our gross profit and we've maintained our gross profit margin, which will drive a greater financial bottom line in our business. 

The reason that I feel this is the most relevant number inside your business is that this will continue to tell you the costs associated with delivering your revenue. And again, if we're looking at growing and scaling a business, we need to make sure that when we're growing and scaling that we're not losing our profitability along the way and monitoring that 70% to see if it goes to 71 or 69.

Understanding what that means, why did that cost go up?

Why are we losing profit?

Because if all of a sudden you're driving more revenue and you're only making half the amount of profit, right? We go from 70% down to 35%. We're going to have to double our revenue to end up with the same bottom line income.

This is a major problem with so many entrepreneurs, is that they start growing and scaling, but they're not making money off of that sale or service that they're delivering, which means that we're actually not making more money in the bottom line.

So why as an entrepreneur, would you want to take on the extra risks associated with growing and scaling a team, taking on extra expenses, more cash flow risk?

If you're not going to have higher financial performance in your business, make more money. Because at the end of the day, if you're having to do twice the amount of work for the same amount of money, it doesn't make a whole lot of sense. 

So again, the importance of this number is to continue to track it and make sure that you're going up and not down as far as a gross profit margin inside your business. The very first step would be making sure that your bookkeeping and your financial reporting are up to date so that you can continue to monitor those and make sure your business is heading in the right direction.

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