- What is your gross profit ratio?
- How does your gross profit ratio impact your business?
- The easiest way to improve your gross profit ratio
- Modern digital tools that benefit your gross profit ratio
Q: What is a gross profit ratio? How can I improve my company’s gross profit ratio?
A: Gross profit ratio is a measure of your business’s profitability – reflected by a percentage. You can improve your company’s gross profit ratio by reducing operational costs, building out your business infrastructure, and using a Virtual Office.
In our increasingly digital world, starting a business has never been easier.
The e-commerce market continues to expand, people spend an astronomical amount of time online, and modern digital-business solutions have made it possible to run a business from anywhere in the world.
With this kind of streamlined entrepreneurship in conjunction with the “payment-first” minded workers of the Great Resignation, business owners can start new ventures to focus on digital-first operations, pivot their existing businesses to include online operations, or even direct all of their attention to the online world.
In addition to the ease of focusing on online operations, the overhead of running a digital business is significantly lower than the cost of renting commercial space with a 3-5 year minimum lease.
But surely it isn’t that simple. If it were, everyone would own a business.
To succeed in this fast-paced environment, modern business owners need to understand the significance of a strong gross profit ratio.
But what is your business’s gross profit ratio? How many different ways are there to categorize the money your business makes?
Essentially, the gross profit ratio meaning is a measure by which the efficiency of your production process is judged. If that’s not clear yet and you’re hoping for a better gross profit ratio interpretation – you’re in the right place.
In this article, we’ll be discussing what gross profit ratio is, how your gross profit ratio impacts your business, and the easiest way to improve your gross profit ratio. Then we’ll look at some modern digital tools that can benefit the company’s net profit.
- What is your gross profit ratio?
- How does your gross profit ratio impact your business?
- The easiest way to improve your gross profit ratio
- Modern digital tools that benefit your gross profit ratio
What is gross profit ratio?
Before we dig into what gross profit ratio is, let’s take a moment to provide a gross profit ratio definition and a closer look at what gross profit is in general. Then, we’ll take a quick look at the difference between net profit and gross revenue before moving on.
While a detailed guide to social media marketing costs is a great way to determine how much your company should be spending on digital advertisements, you’re still in the dark unless you’re able to determine precisely how profitable your business is.
Read more: The Small Business Owner’s Guide to Social Media Marketing Costs
Despite the usefulness of social media advertisements, it’s almost impossible for you to gauge appropriate pricing for marketing initiatives if you’re not sure of your company’s gross profit ratio.
Gross Profit
Gross profit is the amount of money your company has left over after accounting for the cost of goods sold, or COGS.
To calculate your business’s gross profit, you only need to subtract the cost of goods sold (COGS) from your business’s total net sales.
Your company’s gross profit will be reflected as the amount of money it has left over after paying for the direct cost of producing the goods or services sold.
Net profit vs. gross revenue
Net profit and gross revenue are frequently misnomered – but both are great gauges of your business’s current financial position.
Because both of these terms apply to the money your business generates, it can be easy to confuse the two, but that said, let’s take a look at the differences.
Gross revenue is the total amount of money your business has generated through selling its products or services – before deducting any costs or expenses.
Net profit refers to the amount of money your business has truly earned once all applicable operational and business expenses, interest charges, and tax payments have been accounted for and subtracted.
Now that we’ve explained some related terms, we can look into gross profit ratio. As you can imagine, your gross profit ratio is a measure of your business’s profitability that considers the costs associated with making sales.
Your gross profit ratio is calculated by dividing your business’s gross profit by net sales.
The idea behind doing this is to understand how much profit you make on each sale.
When looking at your company’s gross profit – it’s just an arbitrary number. Using the aforementioned gross profit ratio formula, you can turn that number into a percentage that gives you an idea of exactly how well your business is doing.
Why your gross profit ratio matters
As the income gap in America continues to widen and fears of a recession continue to frighten the country, you need to ensure your business is as profitable as possible.
According to Pew Research, income inequality can be measured in several ways, but all of these methods give the same result: the income gap in America has increased by almost 40% since 1980 – more than any of its peer countries.
As working and middle-class families continue to lose purchasing power, your business needs to get the most out of the money it’s bringing in.
Making use of creative marketing ideas and connecting with consumers is a great way to bring in additional revenue. Whether through creative social media marketing or making interesting and fruitful sponsorships, the more your business stands out, the better.
Read more: Creative Marketing Ideas: Surprising Benefits and Inspiration for your Remote Business
That said, your business infrastructure must support a strong gross profit ratio before you start spending money on expensive marketing initiatives.
Think about it – if you haven’t built your business infrastructure to handle new sales and challenges, there’s a chance you won’t be able to keep up with the demand your marketing plans helped create.
Not to mention, your gross profit ratio might be so low that the marketing budget pushes you over the edge, forcing your business to operate at a net loss. Thankfully, once you know what you’re measuring, you can begin understanding how to improve your gross profit ratio.
Using your gross profit ratio as a measure of your profit per sale is uniquely helpful to your business for a couple more reasons. Below, we’ve covered each of these reasons in more detail.
- How much you’re making per sale
- First, knowing how much your company makes on each sale helps you understand how profitable each of your offerings is. If one of your offerings has a gross profit ratio that’s much higher than another, you can use that information to help determine the direction you’d like to guide your business in the future.
- Planning ahead
- Next, your gross profit ratio allows you to plan for future profits. Sure, you shouldn’t spend money before you make it, if possible, but using past performance to get an idea of what to expect is a great way to keep your business prepared for anything.
As you can see, tracking your company’s gross profit ratio helps you to get a sense of how efficiently your business is operating. In addition, your gross profit ratio will inform you early on whether your business is generating enough revenue to cover its operational costs.
Thankfully, you don’t need a gross profit ratio calculator to figure out how efficiently you’re operating. Remember, the formula is as simple as dividing your business’s gross profits by its net sales (and multiplying that number by 100 to make it a percentage).
Before we move on, let’s take a moment to examine a gross profit ratio example to ensure that the concept is clear. In this example, you’re the owner of Company A.
Company A resells digital and physical collectibles, so its COGS, or cost of goods sold, will only reflect the original purchase price of the products that are later resold.
In its first year, Company A made $150,000 in total revenue with a gross profit of $60,000.
Using the formula above, we divide $60,000 by $150,000 – leaving us with 0.40 – multiply this by 100, and we can see that Company A’s gross profit ratio is 40%. So, for every $100 that Company A generates – it is keeping $40.
Although this is just an example to help you understand why your gross profit ratio is important, companies like Amazon showed investors, consumers, and future business owners alike that a 40% gross profit ratio isn’t unrealistic for digital businesses with a robust infrastructure.
That said, it’s a good idea to shoot for 40% while accepting that you might not be able to reach that kind of profitability immediately. According to Forbes, solopreneurs and companies without employees should range between 50%-80%, but companies with employees should try to break into the 20%-25% range.
Now that you understand why your gross profit ratio is such a fruitful metric, let’s look at how what your business can do to improve it.
How to improve your gross profit ratio
Although there are several different methods that you can use to bolster profitability and improve your gross profit ratio, they all boil down to two key factors.
- Reduce expenses per sale
- Increase gross revenue per sale
Most businesses focus almost exclusively on the latter. They pour all their efforts into boosting the prices of their goods or services and trying to continue winning over new consumers.
While this might work for a time, it has its limits. Consumers are only willing to pay so much, and economic uncertainty drastically reduces this amount.
In addition, businesses that push in this direction open up space for competition to undermine them and win the market by pricing their products lower.
It’s easy for business owners to look at some well-known unicorn valuations and make the assumption that growth, at any cost, is more important than profitability.
In reality, this couldn’t be further from the truth. Most companies aren’t going to be the next SpaceX or Uber.
Focusing on increasing gross revenue without paying attention to your business infrastructure will almost always result in terrible productivity, poor customer reviews, and unengaged employees.
Read more: The Counterintuitive Secret to Engaging Remote Employees
Focusing on increasing revenue without a strong business infrastructure will often lead to some stressful situations when faced with the following:
- Unprepared for shifts in the market
- You’re focused on securing new customers and expanding to new markets. In focusing on these ventures, you don’t have the capital on hand to make it through a long-term downturn in the market.
- Poor customer service
- Chasing revenue often leads to simply raising the prices of your offerings. When you do this, you’re alienating your early customers and sending them a clear message that profit is more important than people.
- Unclear future
- When will you know you’ve grown enough? Impulsive growth and chasing revenue can leave you and your employees with a gnawing, “when does it end?” feeling that makes the future seem very bleak.
- This unclear future can lead to job burnout, poor employee retention, and overwhelming pessimism hanging over your company.
- Easy to struggle with financial planning
- When you’re spending money faster than you’re making it, precise bookkeeping is difficult. The possible ramifications of misreporting income are appalling, so even outside of improving your gross profit ratio, a clean book is paramount to your company’s success.
In situations like these, your business might be forced to take on unattractive loans, fire key employees, max out available lines of credit, and in more serious cases, you might have to shut your doors.
Thankfully, there’s another option. A better, often underutilized avenue is to reduce the cost of each sale.
Instead of a blind focus on growth, you can reduce operational costs and build out your business infrastructure to make the most out of the revenue you’re already seeing. Reduced operating expenses mean reduced overall costs that are associated with each sale.
Not only does this help you grow your profits without having to push prices higher, but you’re also able to better prepare for future sales.
Below, we’ve listed some essential tips to help you reduce operating costs and, by extension, increase your gross profit ratio.
- Review existing contracts
- Outsource non-core operations
- Use business growth stages
- Streamline what you can
- Cut expenses
Review existing contracts
All too often, business owners unknowingly enter contracts with almost predatory terms.
A great way to improve your gross profit ratio is by examining all of your company’s contracts and attempting to negotiate better rates wherever possible. These could be your contracts with service providers, vendors, or anything related to your business’s core functions.
Outsource non-core operations
Hiring employees is incredibly pricey and time-consuming. But unless you’re a solopreneur, this isn’t something that can be avoided.
When hiring, you have to find employees you mesh well with, which requires time. You also have to find employees that are motivated and willing to work, which also takes time.
The onboarding process can be fairly expensive, and if your new hires aren’t picking up on the necessary information, you’ll likely have to continue spending money.
Needless to say, outsourcing talent when possible is a fantastic way to save you time and money.
Whether it’s utilizing a Live Receptionist to help with constant phone calls, hiring a web developer to build your company website, finding a marketing company to direct your company’s advertisements, or anything else you can outsource, you will almost always save money.
Keep in mind, you generally shouldn’t outsource key elements of your business’s operations.
Outsourcing is great, but without a core team to help your business function like a living organism, you’ll likely wind up doing more work with outsourced labor than poorly hired labor.
Use business growth stages
The business growth model breaks each stage a company goes through into five parts: existence, survival, success, take-off, and resource maturity.
With this model, you can identify aspects of your company’s infrastructure and financial security that you should focus on depending on how far along your business is.
Read more: Identify Your Business Growth Stage to Maximize Profits
Streamline where possible
Regardless of how well your business operates, you can always find some kind of inefficiency.
Thanks to the countless automation tools available for the modern small business owner, you can automate just about any one of these inefficiencies.
With services that handle your company’s bookkeeping, deal with payroll, data entry, or even automated email campaigns; the choices are truly endless.
Cut expenses
Directly cutting your expenses is an actionable way to improve your gross profit ratio – A Virtual Office offers an ideal way to do this.
The traditional commercial lease can last anywhere from 3-5 years. With a Virtual Office, you’re given a cost-efficient way to avoid those kinds of lengthy commitments.
Additionally, you’re saving tons of money by reducing one of your biggest expenses: rent.
With Alliance’s Virtual Offices, you’re able to register your business in any state and almost any major city you can imagine.
Because all of our offices are backed by physical space, you can give your company a professional and well-known address that legitimizes your company in the eyes of investors, clients, and consumers alike.
Also, our Virtual Offices are all backed by physical space. This means that when burnout is creeping up on you and you’re ready to break the monotony of working from home, you’ve got a quiet and polished space that you can use to allow yourself to refresh.
With mail forwarding, friendly and professional onsite staff, and easily reservable meeting rooms for any sized business meeting you’d like to host, a Virtual Office provides a cost-efficient alternative to a traditional office while still retaining all of the key benefits.
Modern digital tools that benefit your gross profit ratio
Your gross profit ratio is the amount of profit your business makes divided by net sales.
While businesses try to increase the ratio by charging more per sale, this can ultimately backfire, allowing competitors to win the market and poach customers.
Instead, using a Virtual Office to reduce operating expenses can help you earn more on the business you’re already doing – without having to charge more.
Your Virtual Office will save your business a considerable amount of money on rent, allowing you to reinvest back into your company. Beyond those savings, your Virtual Office will continue to reduce your operational costs by providing access to coworking spaces and meeting rooms as necessary.
Outside of the Virtual Office, Alliance provides several other tools for established entrepreneurs, future business owners, and everyone in between.
Our Live Receptionist is the perfect alternative to a full-time hire.
Don’t risk missing phone calls or trying to multitask while listening to your customers. Instead, allow our friendly receptionists to personally answer and screen your calls.
This means fewer distractions for you, less money spent onboarding new hires for your business, and a great first impression for potential customers.
Using our Virtual Phone Number helps you to create a better work-life balance while effortlessly connecting your team.
With the Virtual Phone, you can keep your personal and business numbers separate and seamlessly add new extensions for new hires, all while keeping your phone number and your employees’ phone numbers completely private.
Check out Alliance Virtual Offices to see what other services you can use to improve your gross profit ratio!
Further reading
- Social Media Marketing Costs for Small Businesses (Free Guide)
- The Counterintuitive Secret to Engaging Remote Employees
- Creative Marketing Ideas: Surprising Benefits and Inspirations for your Remote Business
- Identify Your Business Growth Stage to Maximize Profits
Alliance Virtual Offices provides business services for the modern entrepreneur.
It doesn’t matter if you’re a brand-new business owner hoping to build out the strongest infrastructure possible before expanding, or if you’re a long-time business owner hoping to improve your gross profit ratio to increase your net profits, Alliance has something for you.
Don’t make the same mistakes as other entrepreneurs and focus too much on growth before you have the systems in place to handle the larger scale. Contact us today to see how Alliance Virtual Offices can help improve your company’s gross profit ratio!
