Written on the 8 February 2014 by National Australia Bank
Gross profit margin
Your gross profit margin is your gross profit as a percentage of turnover. For example, if your turnover is $2 million and your cost of sales is $600,000, you’ve made a gross profit of $1.4 million. It’s easy to turn this into a percentage: 1,400,000 ÷ 2,000,000 x 100 = a gross margin of 70%.
So every $100 of sales generates $70 that goes towards paying for expenses and towards your net profit. If this gross margin percentage starts to slip over time, it’s an indication that you need to find out why and take action. The reasons may include:
•rising inventory costs
•theft by customers or staff
•selling products that have lower margins.
Net profit margin
Your net profit margin compares your net profit (gross profit less fixed or indirect costs) to turnover. For example, for a business with a turnover of $2 million and a net profit of $300,000, the net profit margin would be $300,000 ÷ $2,000,000 x 100 = 15%.
Again, if the net profit margin falls, it means you’re paying proportionately more in expenses than you should be.
Expressing net profit as a percentage is particularly useful for identifying problems you may not expect.
For example, suppose that your turnover increases from $2 million to $3 million and your net profit goes up from $300,000 to $400,000. On the surface this all looks good but let’s now work out your net profit percentage: $400,000 ÷ $3,000,000 x 100 = 13.3%. That means your net profit margin has actually deteriorated from 15% in the first example to 13.3%. Your turnover has increased by a million, and your net profit by $100,000, but you’re actually not making as much profit from that increased turnover. Talk to your accountant and identify which costs have increased out of proportion to the rise in sales, so you can stop the slippage.