How to Determine Gross Margin - WEbinar REplay

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Delegate CFO: Hello, everyone! Welcome to our webinar how to determine gross margin.

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Delegate CFO: My name is Steve Hovland. I’m a Cpa. And certified forensic accountant. I’ll be your host and presenter today, and I want to thank you for joining us

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Delegate CFO: before we get started. Just a few quick housekeeping notes.

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Delegate CFO: This session will be about 30 min. Give or take questions, and we will be recording this webinar, and we’ll send out a replay and the slides to everyone afterwards. Please use the Q. And a feature in zoom to submit your questions at any time during the presentation. There will also be dedicated time to the Q. And a at the end. If there are questions that come in that mirror, a slide or upcoming slide, I’ll probably answer those during the respective presentation. So

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Delegate CFO: again, today’s topic, we’re going to be diving in that. A topic is really fundamental to any business owner manager, and that’s really gross margin and gross margin. If you think about. It is one of the core pillars to your income statement and to a successful business.

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Delegate CFO: whether you run a large company, small company, or just curious about the metric understanding. The gross margin will really help you make smarter decisions, set the right price and ultimately increase your respective profits.

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Delegate CFO: So let’s go ahead and jump into the respective presentation today. So

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Delegate CFO: first, st item, obviously, you know, we’re going to go through how to determine this. And

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Delegate CFO: really, our agenda today is

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Delegate CFO: we’re going to say what is gross margin. You know, we need to come up with a definition. And while the definition may be simplistic, there’s a lot of nuances that go into the actual calculation.

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Delegate CFO: Then we’ll go over. Why does it matter? Why? Why are we doing this calculation? And why are we dedicating an actual webinar just to this particular topic? Then, of course, we’ll go through on how to calculate gross margin, do a sample company, and go through and give how important or how to improve your gross margin.

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Delegate CFO: We’ll be talking about improvements throughout the respective webinar. So it’s not just going to be at that slide. So just be be aware, as we go through, we’ll be given little tidbits as to

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Delegate CFO: really how to improve your your respective gross margin.

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Delegate CFO: So first, st the definition.

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Delegate CFO: your gross margin really is going to be the difference between revenue and your cost of goods sold. So it’s really a simplistic formula, as you see there on the slide

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Delegate CFO: revenue, minus cost of goods sold that equals your gross margin.

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Delegate CFO: What this really does is, it measures how much money a company keeps from its sales after covering the direct cost of production and technically indirect cost of production, to sell that respective good and or service.

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Delegate CFO: and so again, that very simplistic formula. But as we see as we go through this respective webinar, there’s a lot of nuances that go into each of these little items of the calculation. Think of the formula as kind of like the high level, and then there’s all little subcategories within the respective numbers on the cost of goods sold and revenue side that focus into the respective gross margin.

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Delegate CFO: One of the questions actually just came up. This came up right before we started is, isn’t gross margin just another name for profit margin?

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Delegate CFO: Well, no, that it’s not the same name, and and I’m glad you brought that up, because.

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Delegate CFO: unfortunately, in the accounting world and in in particular on the income statement, there are a lot of terms that sound alike, a lot alike that aren’t.

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Delegate CFO: And then there are some terms that don’t sound alike, that actually are the exact same thing. So just to make everything more confusing in the world

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Delegate CFO: back to the question, isn’t gross margin just another name for profit margin

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Delegate CFO: again, gross margin is really, as we just saw in the formula, revenue minus cost of goods sold

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Delegate CFO: profit margin is, after you take into account all your operating expenses. So you have your your gross margin, minus your operating expenses and operating expenses are usually going to be such things as sales, marketing, admin, etc. All the items that aren’t really related to the cost of goods sold.

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Delegate CFO: Take those out, and then you get to your profit margin.

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Delegate CFO: A better way to think of profit margin is to think of it as net margin.

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Delegate CFO: because your net margin is really going to be your more or less your net income. And when you go through that process you ultimately will start to calculate a percent as well, which is going to be the net margin which is going to be your net income. Divide it into your sales, and you’re going to get a percentage. Usually it’s like 2, 3, 4, 10%.

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Delegate CFO: Gross margin, on their other hand, is always going to be a lot bigger percent. Again, gross margin is revenue minus cost to get sold. It’s your gross margin, your gross margin divided into your sales will get you a percentage. And normally, those 2 percentages are not anywhere close to one another. So

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Delegate CFO: anytime you hear the term profit margin. Just start to think net margin and net income, and that’ll help with that respective aspect.

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Delegate CFO: Now, why should you really care about gross margin?

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Delegate CFO: Well, ultimately there’s many, many factors. But you know, just, you know, for this respective webinar.

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Delegate CFO: it helps show how efficient you are on producing goods and services.

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Delegate CFO: and that efficiency really will come through on the actual percentages. And we’ll get to the the percent calculation on another slide.

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Delegate CFO: But when you take your sales minus your cost of goods sold, and you get your gross margin and you divide whatever that number is back into your sales. You’re going to get a percentage.

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Delegate CFO: That percentage will help dictate, really, how efficient you are and the way you determine how efficient you are is

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Delegate CFO: comparing it to historical, gross margin percentages, and or, more succinctly comparing it to your industry. You know that percentage is lower than the industry, you might not be as efficient as the industry, you know, all things being equal. And so that’s really the key there is, it helps you determine. Are you being efficient because you could be in an industry that has, let’s say, a gross margin of 70% margin divided by sales equals 70%,

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Delegate CFO: and you’re at 30. So there may be a massive inefficiency issue. You know, people don’t be time into it, probably not getting done, etc, etc. So

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Delegate CFO: also the margin helps you set the price and evaluate the health of the business health

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Delegate CFO: when you’re determining your gross margin. And let’s just say you’re you’re going to produce a widget, and it’s a brand new widget. You haven’t done this before. Obviously you want sales minus the cost of goods sold equal a positive number.

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Delegate CFO: whatever that number may be. And so if it doesn’t, if you know it costs you $10 to make a widget, you’re not going to sell it for $10 because you’re not even going to cover your operating cost after you sell that. And so that really helps you determine. Okay, what price do I want to set? And we’ll go in more succinctly as to how to better set that price here in a little bit. But that margin really helps you to determine what

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Delegate CFO: is the best price or what price should you know? What’s my minimum price that I should set?

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Delegate CFO: And then, finally, it’s essential for growth and long term profitability.

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Delegate CFO: And the reason why that is considered essential for your growth and your long term profitability is

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Delegate CFO: when you have a low margin, and your margin is barely covering your operating costs. You’re not really going to grow, you know. You may be breaking even, but you’re not going to grow. And you’re not going to have long term profitability

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Delegate CFO: kind of a real world example. We had. Our firm took on a manufacturing claim.

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Delegate CFO: and this client had been in business for 30, 2030 years, and they sold to a new owner, and the new owner brought us in to start doing Cfo work for them. And when we start looking at the respective products, and this is a manufacturing company, we’re looking at their products.

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Delegate CFO: their sheet that showed all their margins on the products. Were these huge margins, I mean, we’re talking 80%, 90%, I mean, very, very large, gross margin for their particular industry. It was. It was way above the industry norm.

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Delegate CFO: and yet their net income was always, you know, barely break even just a little bit of net income. They didn’t have a whole lot of net income.

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Delegate CFO: and we started diving into it, and we realized they were calculating their gross margin incorrectly. And so they were setting their prices based off of an incorrect calculation. So just in case you’re curious, they were taking sales minus materials and saying, There’s my gross margin. They weren’t including labor. They weren’t including overhead. And so based on that.

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Delegate CFO: there was a reason why they weren’t making lots of net income, you know, each year, or even growing each year when they should have been growing each year. And it was really because their formula was incorrect. Now there was other inefficiencies and supplier issues and all that

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Delegate CFO: But

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Delegate CFO: at the core they weren’t calculated correctly. So when you don’t calculate that correctly, you don’t know if you’re selling it properly or not. And so that’s why it’s very essential for your growth and your long term profitability. Do you mind this company been around for 30, some years, and

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Delegate CFO: they probably left who knows how much money on the table, for just by not doing that calculation correctly.

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Delegate CFO: Now, key components, as we mentioned. You know the formula again, revenue minus cost of goods sold

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Delegate CFO: equals your gross margin. You know. Revenue is really going to be total sales

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Delegate CFO: or income from, you know, the product and services, you know, gross margin does tie back into the service industry as well, and by service industry. You know, it can be software industry. It could be professional industries, such as accounting legal attorney or law firms.

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Delegate CFO: So it goes back into that. You always want to have a calculation on gross margin, and you know your 1st step is going to be a revenue. Now. The second step is going to be your cost of goods sold. And again, in that previous example, we’ll kind of use that as we walk through this.

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Delegate CFO: your cost of goods sold is going to be made up of 3 main items. Now, there’s various subcategories within these main items, but your 3 main items are going to be your direct labor, your direct materials

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Delegate CFO: and your overhead.

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Delegate CFO: Now, materials is usually the easiest one, especially if you make a physical product. How much steel goes into making this widget. That’s pretty much that’s pretty easy. But then you need to know how much labor does it take to produce that? Because when you get that shipment of steel in, it’s not a product. It’s not a widget, you know. Somebody has to do something to it to get it down the line. And so that labor that goes into producing that product is considered part of your cost of goods sold.

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Delegate CFO: and then the other item are your indirect costs.

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Delegate CFO: Now your indirect costs are going to be your overhead, and your overhead is the best way to think about it is

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Delegate CFO: if you’re building widgets, and you’ve got a big, huge warehouse, and it’s a big, long assembly line of all sorts of machines on there, and you have your your employees going through, and they’re doing different parts of the step on the symbol line, you know, putting the widget together.

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Delegate CFO: The easy parts are the late, the materials. You know. You know how much product you’re gonna have to, you know, use to build that one widget.

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Delegate CFO: You know how many hours it takes those employees to go through and put those items together.

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Delegate CFO: But what about the cost of the electricity to run that line or to heat the building for that part or the lights? Because you need to be able to have lights on there. Those are all costs really related to the product. But you can’t specifically say it goes directly to this respective item, ie. This widget, and so those costs need to be brought in to your respective cost of goods sold.

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Delegate CFO: And this is where, in my previous example, where that that historic that’s mature company

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Delegate CFO: had not included labor or overhead. If they had included labor, and overhead they would have increased their sales price significantly over what they had been doing.

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Delegate CFO: And so those products, those different items, go into your cost of goods sold. So again, our simplistic formula is revenue minus cost of goods sold equals gross margin.

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Delegate CFO: There’s a lot that goes into that cost of goods sold. And if you recall in our previous slide where we talked about efficiency. This is where you start to determine. Are you being efficient

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Delegate CFO: now? You can increase your sales price, you know, to to increase your gross margin. That’s that’s an easy thing. But we’re gonna make an assumption. You’re already maxed out on your sales price. You know. You’re selling your widget for $9. Your competitors are selling for $9. We’re maxed out on that

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Delegate CFO: where we can be efficient and where we can increase our percentages. And by efficiencies. What I’m saying is, you’re increasing that gross margin percent. So in other words, you’re reducing cost of goods sold

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Delegate CFO: and the area we can reduce it. Well, one, we can get a better terms with our suppliers for materials. That’s

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Delegate CFO: can happen not always, but that can’t happen.

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Delegate CFO: But then direct labor and direct labor and the overhead are the areas where we can determine or we can control those costs. So let’s say hypothetically, you have to do 100 widgets, and the direct labor hours is about 100 h.

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Delegate CFO: If it takes 200 h to produce those widgets, you know, double the amount of time that was budgeted.

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Delegate CFO: You’re going to have inefficiency. So you’re going to have more cost getting dumped in that cost of goods sold. Conversely, you’re also going to have more overhead getting dumped in because, keep in mind, overhead is allocated, based, usually based on labor hours, sometimes on machine hours or a specific shop rate based on the product. But there’s some sort of allocation for the overhead. And so if you have more labor hours going into the product to produce it.

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Delegate CFO: you’re not only putting more direct labor in, you’re putting more overhead in. And so you think about it. You’re starting to put more cost of goods sold in. That means your margin is lower. That means your percentage is lower. And thus that’s how you determine your efficiencies. So if you’re historically, your gross margin is at 20% from the company as a whole. And you’re at 10%. And nothing really has changed sales. Prices haven’t really, you know, there’s no impact on sales, prices or anything.

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Delegate CFO: Usually it’s gonna be an efficiency issue. And from there you can determine. Okay, why is it taking, you know, my employees so long to be able to produce this particular product. And so

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Delegate CFO: that’s where you start getting into the efficiencies and understanding. Hey? If I can control these efficiencies, I can have more gross margin and gross margin percent

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Delegate CFO: so real quick. Just so you can see an example. You know, we we’ve talked about this

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Delegate CFO: verbally. But this, so you can have a visual appearance on the gross margin. Again, formula. Revenue minus cost of goods sold, divided by revenue gives you your percent. So margin is revenue minus cost of goods sold the percentages divided into the revenue. So in this situation we assume we have $50,000 in revenue.

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Delegate CFO: Cost of goods sold is at $30,000. So then, our margin is $20,000, $20,000 into 50,000 in revenue gives us a 40%. Now.

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Delegate CFO: the book textbook formula always says to times by 100%, you don’t have to do that as long as you understand that after you do the calc, it’s 0 point 4 and 0 point 4 equals 40%. As long as you’re consistent with your format. So don’t flip back and forth, you know, getting used to 0 point 4. And then all of a sudden, you did 100%. Now, you think you have

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Delegate CFO: 40,000% or 400%, or whatever the the case may be.

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Delegate CFO: just keep that in mind is.

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Delegate CFO: if whatever way you do this for me, just be consistent with it.

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Delegate CFO: So again, another example, you know, we just kind of went over. This is, we have revenue 120 cost of goods sold 90, that ultimately comes out to a gross margin of 25%.

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Delegate CFO: And again,

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Delegate CFO: put this slide in here to highlight the fact that we have 2 separate terms in here, but they actually mean the same thing. So I got gross margin and gross profit.

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Delegate CFO: Those terms will get used interchangeably, and they really mean the same thing. And that’s why I was mentioned before when we had the question on

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Delegate CFO: profit margin. This is where we start getting confusion and using terms back and forth. So gross profit and gross margin are really one of the same. It’s just you’ll hear the term.

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Delegate CFO: Some people may say margin. Some people may say, profit. So keep in mind. Those really are one of the same also, just you know, it’s not on the respective slide, but the acronym is going to be GM. For gross margin, Gp for gross profit. But ultimately, when we’re going through and calculating, we want to obviously know what the dollar amount is.

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Delegate CFO: But more importantly, we want to know what this percent is because we can manage if we understand this percentage just makes it easier to manage and in particular, when you’re looking at just individual products, because you want to do this margin not only just and total for the company as total.

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Delegate CFO: You also want to do it for each of your products or each of your services. So if you do service a service, B, you want to know what that margin percent is because ultimately, that’s gonna come back to into our next slide where we’ll we’ll start talking about break even percent.

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Delegate CFO: Now, what is a good gross margin.

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Delegate CFO: It really varies by industry. And on this slide you’ll see various different ones. And this is just a highlight, you know, kind of

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Delegate CFO: gross margin percent. You know, grocery stores at 2025 restaurants, 60 to 70 software, 70 plus

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Delegate CFO: depending on what kind of industry you’re in

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Delegate CFO: will dictate whether your margin is good. So again, if you’re in software industry, and let’s say the norm is 70%. But you’re at 20%. You know, you definitely are not anywhere close to that and so that’s why you want to make sure you understand what your your industry one and just happen to have a question here and and came in earlier. But I’m pushing it to this particular slide. It’s that question is, are there industry benchmarks I should be using. Compare my gross margin.

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Delegate CFO: and the answer is unequivocally, yes.

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Delegate CFO: You want to be able to

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Delegate CFO: compare to your industry, and in our firm. What we do is we actually use a software or a service called Ibis world. Ib, IS. World, and they have a lot of industries that they do analysis on, and they have a lot of respective information data that we use in comparison. When we in particular, when we bring on a new client.

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Delegate CFO: and you want to be able to have access to something like that. Now, you may have access to industry, specific guidance depending on what industry. And so you know. For instance, if you’re in the textile industry, you may have a subscription to an industry magazine or industry documents that show what the percent is.

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Delegate CFO: But either way you want to be able to have access to that persona. Now, one of the things that gets tricky

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Delegate CFO: is a lot of times. What you’ll see is you’ll get industry, guidance, but it might not match exactly your industry. So you may be doing some textile, but you may also be doing fishing line. You know. Both of them use the same machine, the same raw materials.

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Delegate CFO: but those are 2 separate industries

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Delegate CFO: for the most part, and so sometimes you have to use industry reports for 2 different industries and kind of mesh them together.

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Delegate CFO: Either way, you want to be able to use that to determine what is your gross margin percent. Now.

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Delegate CFO: in the respective, in your gross margin percent.

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Delegate CFO: this is a key to understanding. Are you going to be making money after everything’s done. So again. Gross margin. We’re just talking about revenue minus cost of goods sold.

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Delegate CFO: but you also have your other expenses, your operating expenses again, more or less. Those are going to be your sales, marketing, admin, etc.

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Delegate CFO: You have to cover those so that the end of the day when you get to your net income. It’s positive

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Delegate CFO: worst case scenario at 0. Really, worst case scenario is negative.

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Delegate CFO: But we need to know what our percentages are, one, what the industry is so we can compare to the industry and understand. Are we meeting the industry requirements.

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Delegate CFO: or are we meeting the industry requirements? But are we also hitting

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Delegate CFO: getting past our break even percent. Now, real quickly. This is kind of, you know, we’re kind of diverting into another webinar.

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Delegate CFO: But your break even percent is usually calculated by taking whatever your operating expenses are. Again, your sales, marketing, rent, etc. Admin

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Delegate CFO: whatever that total is and divide it into your sales, and you’ll come up with percent.

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Delegate CFO: So let’s say hypothetically, it’s 20%.

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Delegate CFO: And so what that means, if you walk through the formulas is your gross margin percent has to be a minimum of 20%. So let’s let’s put some numbers to that. So it makes sense.

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Delegate CFO: Let’s say your operating expenses are $200,000. And it’s 20% of your sales. So your sales bus, or a million dollars a million dollars in sales, 200,000 in operating expenses. So that’s 20%. So that means at a minimum, we want to make our gross margin percent to be 20%.

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Delegate CFO: So we go through that that means our gross margin dollars need to be 200,000 plus 20% of 1 million. And then that covers our operating expenses. And so that’s why it’s important, as you recall that you do your gross margin as percent. Yes, dollars are important. But we want to do a percent, because we want to know? Are we going to be covering our costs? Are we going to be breaking even? And so that’s what kind of dictates that is.

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Delegate CFO: we want to know what percentage is. We want to know how we’re doing for industry, because we want to be able to know, can do we have efficiencies that we can gain.

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Delegate CFO: But we also want to make sure that we’re breaking, even at least breaking even I should say so are we even covering our costs, because it doesn’t do you much good if you have $100,000 of gross margin. But your operating expenses are 200,000, so that means you lost 100,000, you know, for the year month. However that may be.

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Delegate CFO: now tips to increase the gross margin. Now, of course.

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Delegate CFO: obviously, you can increase your sales price. And

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Delegate CFO: you obviously have to do that strategically. You’re selling widget.

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Delegate CFO: your competitors selling widget. You sell them for the same price. You probably can’t increase the sales price. However, if you’re selling a widget that has an a attachment, and you’re the only one that sells with the a attachment. Well, you can probably increase that sales price because you’re the only one doing that. So again, it’s very much a strategic process to identify. Can you raise sales price.

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Delegate CFO: reduce your production costs again, kind of goes back to your efficiencies, you know, in every process you have, whether you’re building a physical product or you have a service, you should have a budget for whatever that project is. So it’s a physical process, you know, when you’re manufacturing, your bomb report should indicate. Okay, if we’re going to build a hundred widgets.

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Delegate CFO: the total budget hours is 10 h. You need to have some sort of barometer to be determined. Am I even being efficient with my labor hours? Same thing with service, you know. If you’re a service industry.

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Delegate CFO: you should have a budget on the total budgeted hours on there. So use that to determine. Okay, here’s my budget. How many hours do I get in there? Can I reduce my budget or reduce my production costs. Obviously, if you can reduce your materials, that’s great. But usually it’s going to be in labor and keep in mind if you’re able to reduce your labor hours. Usually. That’s going to mean you’re going to be reducing your overhead allocation as well. So you get kind of a double

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Delegate CFO: double bonus when you do it correctly, but kind of double whammy when you don’t do it correctly. Obviously negotiate better, supplier terms. That’s kind of a given

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Delegate CFO: inventory. Improve your inventory management.

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Delegate CFO: Now, this really comes into effect when you have to order raw material in particular from another country. So let’s say you have to get something a specific type of inventory. Let’s say it’s from Switzerland, and they have set standards that that’s the only place you can get this particular piece of inventory from.

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Delegate CFO: You need to make sure that you understand your safety stock and how long it takes from ordering that product to it physically arriving.

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Delegate CFO: because what can happen is if you don’t have that in in time, or you didn’t calculate it correctly, and it’s still on a boat coming over the ocean to your respective warehouse.

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Delegate CFO: Your employees gonna be sitting around, and if they’re sitting around you’re still gonna be paying them because you can’t just terminate them and then hire them back in with the materials. Come in.

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Delegate CFO: So you’re going to be incurring costs, and those costs ultimately will eventually get dumped into overhead costs. Get allocated, and then hit your gross margin again. So again, you need to make sure you have very tight inventory management and booking forward, and again, the only way you can look forward is to have a proper budget put together for sales upcoming sales.

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Delegate CFO: And then, of course, you streamline your operations. If you’re building a particular product that has takes up a lot of the employees time. And there’s a lot of you know. It’s very labor intensive, you know. Takes up a lot of materials. Take up a lot of machines.

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Delegate CFO: How can you make it so that product, you know, doesn’t interfere with some of your better producing products. So you know, figuring out a way to one streamline, and also to be able to identify any bottlenecks that may come up.

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Delegate CFO: So now we’re at the QA. And we’ve got several questions that came in. I’ll try to get through as many of these I can. Some of these questions are specific to a company with a company name, so I’ll answer those ones offline. Just so. Those of you who submitted, those those ones. I’ll answer offline just so that we don’t disclose any sensitive information on that. So

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Delegate CFO: 1st question, if I buy inventory in bulk.

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Delegate CFO: but sell it over several months. How do I account for that in my gross margin?

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Delegate CFO: Well, when you buy inventory in bulk, most people do buy their inventory in bulk.

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Delegate CFO: It’ll sit into the warehouse, and however the cost goes in.

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Delegate CFO: and how are your costing systems set up Fifo Bifo average?

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Delegate CFO: We’ll determine how that gets pulled out from a cost standpoint. And now this is also going to be tied to your bomb report.

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Delegate CFO: So your bond report should say, Okay, it’s gonna take 10 pounds of steel to build this particular widgets, you know. 6, you know. 6 pounds of plastic. What have you?

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Delegate CFO: And so it’s going to be pulling those out and pulling those out based on those costs. Those costs get allocated into that and it it trickles on down the line.

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Delegate CFO: Now we run into issues. If you buy in bulk and you have

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Delegate CFO: spoilage or obsolescence issues. So you gotta be careful on how we’re how much you’re buying in bulk, because

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Delegate CFO: if you have to, just, you know, throw away because of you know, it either spoils or eventually becomes obsolete. Say, it’s computer chip or computer board that, you know you can only keep for 6 months because another one’s going to come out, and then those are going to become obsolete. So you want to be careful in that particular respect, but just as a whole those costs will get pulled into the respective accounting system based on how the bomb report is set up. Now.

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Delegate CFO: important note is, make sure you audit your bomb reports because I’ve seen situations where the units of measure in the bomb report was incorrect.

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Delegate CFO: and the people in the manufacturing plant knew that, and they would just automatically fix it, you know, on how they were producing, because they knew that that was incorrect, but nobody told the accounting department so the accounting department’s pulling costs, based on incorrect new measure, and so that messed up the margins, ie. The costs were way too high, or actually the costs were way too low, I should say, and so they were setting their sales price too low. So again make sure you’re auditing your bomb reports.

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Delegate CFO: What are practical steps to improve micros margin? I think we we kind of cover that in depth again. Increase your sales price if if you’re able to

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Delegate CFO: but focus on your efficiencies, how is your percent compared to your industry average? And if your your gross margin percent is 20%. And your industry average is 30%. And you know your sales prices are pretty even. And you guys pretty much pull from the same supplier for the materials

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Delegate CFO: that tells you they’re more efficient in their process than you are. So then you need to analyze your process. Okay, how are they more efficient? Do they have more experienced people on their line, and I’ve got inexperienced people, and that causes more hours in there. Am I not allocated enough resource, ie. Space to be able to produce this quickly, you know. Is it taking more time for them to go from this particular machine

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Delegate CFO: over to another machine type situation. So you you’ve got to analyze almost everything to see. How can you make it more efficient?

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Delegate CFO: How does profit? Or I’m sorry. How does gross margin work. If I’m not selling a physical product

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Delegate CFO: well, gross margin works more or less the same way. It’s just you don’t have quote material you’re you’re

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Delegate CFO: cost is going to be the salaries and burden of the respective individuals, you know. So if if you have a legal firm, so that respective attorneys, you know. Wage, you know, plus this burden plus possibly built in some respective bonuses that’s going to be the core cost. And then, of course you have some overhead and everything. Just so. You know, people out there never worked in professional industry. A very high level rule of thumb is.

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Delegate CFO: you know, when you see a billing rate. So if you have an attorney that has $300 billing rate, they’re not making $300 an hour. Their salary is probably 3 to 3 and a half less than that. Or so. Conversely, they’ve, you know, most professional firms as a starting point will take the salary burden and multiply it by 3 to 4 to come up with a billing rate. So just a little tidbit in case you’re wondering, how do? How do these

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Delegate CFO: professional firms, such as attorneys and accountants? How do they come up with their billing rate? That’s kind of a general rule of thumb. Now there’s a lot more that goes into that. But that just kind of gives you an idea on that.

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Delegate CFO: What should I do if my gross margin comes out negative.

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Delegate CFO: If your gross margin comes out negative.

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Delegate CFO: 1st thing you need to do is

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Delegate CFO: look at your costs. Make sure you’re bringing in the correct costs.

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Delegate CFO: Make sure the costs that you’re bringing in are correct. In other words.

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Delegate CFO: if you’re pulling a line item from the general ledger, and it says,

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Delegate CFO: you know, cost of goods sold, and you’re bringing that in. Make sure. The costs that go in that cost of goods sold truly are cost of goods sold, you know, materials, labor, etc. So go through and make sure all those costs are directly related to that product or service, and or indirectly related to those products and service. So make sure those costs are correct.

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Delegate CFO: Then, after you’ve done that, you know, obviously make sure your sales price is correct. And can you increase your sales price? If, after the end of the day, it’s you know those are correct and it’s negative.

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Delegate CFO: then you need to consider

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Delegate CFO: getting rid of that particular item, because if you think about it, if your gross margin is negative, you’re literally paying somebody to take your product. You know me as customer. Come into your your place of business.

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Delegate CFO: and you’re not only handing me the product, but think about it. You’re almost handing me another $20. So you’re paying me to come and grab your stuff so.

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Delegate CFO: and that’s that’s concern you have on a gross margin.

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Delegate CFO: Should I do this calculation, and by calculation I’m assuming you mean gross margin for each product, or just for the business of the whole business.

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Delegate CFO: You want to do both.

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Delegate CFO: Obviously you want to do the the business as a whole. And again, that the reason why you want to do that is because ultimately you’re going to figure out what your break even percent is. But you want to do it on each product as well.

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Delegate CFO: Because if you know your Breakeven percent and again, just reiterate. That’s your operating expenses divided into your sales. If you know that, that’s 20% that’s really going to be your floor for every single product. You know, you don’t want to sell

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Delegate CFO: or less than 20%, because then you’re technically not covering your your operating expenses. And again, this is very high level.

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Delegate CFO: And so you wanna make sure that all your products are at least that percent.

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Delegate CFO: And if they’re not, then you want to go and analyze. Okay, you know this particular products? 15. But my Breakeven percentage is 20. Okay, do we want to keep selling this? You don’t want to just knee jerk reaction. Say, we’re not selling that anymore. You need to analyze. You know, it could be a new product, that right now it’s 15. But you’re going to sell, you know 100,000 of those units next year as opposed to 10,000. So, in other words, if you think about that.

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Delegate CFO: that is actually a situation where you make it up on volume again, positive percent.

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Delegate CFO: Currently, it’s below your Breakeven percent. And so you need to analyze that now, everything above that usually should be fairly good. But anything that’s right around the break, even percent, even 5% higher than that you want to analyze it and determine

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Delegate CFO: is this something, you know one. Can I increase the the respective sales price?

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Delegate CFO: But 2, is there a benefit to keeping this? You know, it could be a product that. Yeah, the percent is low. But I’m turn around and I’m selling a 40% one with it, you know, to my best clients and my best clients or always order huge orders. Yeah, it’s worth it. But again, you use that percent to determine

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Delegate CFO: initially at the product. Here’s my floor. Anything near that floor below it. I want to analyze it. To see. Okay, is this something I want to keep? It could be something that’s again, we say, 20% break even. But it comes in at 10.

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Delegate CFO: And all of a sudden you decide.

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Delegate CFO: okay, there’s no way. We’re not going to sell a whole bunch of these, you know, it takes up resources, labor, etc.

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Delegate CFO: Let’s scrap it. And so I have seen that situation before where you know, after a thorough analysis by the ownership and senior management. They determine this product’s just, it’s eating into other products. Because keep in mind when you’re building something, you’re taking resources, ie. Time in the day to build something else. And so if you can build a product, that’s 40% margin. But you’re working on this 15% margin.

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Delegate CFO: Yeah, we got disconnected so ultimately. And that’s kind of what happened in this situation. They just got rid of that product. Just said, Nope, we’re not doing it. And conversely.

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Delegate CFO: they ended up having probably the biggest net income year that they ever had. Now, there’s other factors in that. But that was one of the things that came into their their respective management decision.

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Delegate CFO: So the rest of these questions were a little bit over time. I’m gonna go ahead and answer those offline. And then for those of you who put in your actual company name, I’m gonna definitely answer those offline. So I’ll go ahead and respond to those. So for right now

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Delegate CFO: I want to thank you for attending this webinar on how to calculate your gross margin. My name again is Steven Hovland. I’m the owner and founder of Delegate Cfo. You can contact me at steve@delegatecfo.com. You can also learn more about our respective firm@delegatecfo.com

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Delegate CFO: again, recording these materials will be sent out after the webinar. If you’re watching this on replay, and you would like to have the copy of the slides. Please contact us, and we’ll do our best to get those to you in quick and timely fashion. So again, I thank you for attending, and I hope you have a great day. Thank you.