I’ll never forget an investment a client asked me to analyze for them, years ago when I first started my CPA practice in Reno, Nevada.
It was a local micro-brewed beer with a great name, solid packaging, and good price. It looked like a winner based on that criteria. The challenge that the brewmasters were facing, though, was getting product recognition.
To overcome that, they had come up with a very lucrative commission structure for product placement in the store. In fact, they paid out more in commissions to the distributors and the store than they made when they sold the beer.
“That’s what having a loss leader means,” the brewmasters explained. But the business just wasn’t making money yet, so they needed another round of investor money. And that’s where my client came in. He was intrigued, but wanted to make sure it was a solid investment.
I asked to see the commission agreement to gauge how much they were really on the hook for, and for how long. That’s when I discovered that they were required to pay greater than 100% in commissions forever. It wasn’t just a beginning bump to get placement. The commission structure went on as long as they sold beer.
In other words, the sales price of the beer less the cost of manufacturing and cost of selling it gave them a negative gross margin. The more they sold, the more they lost. My client asked them about that, and the brewmasters replied, “Oh, we’ll make it up in volume.” Six months later, the company was out of business, and all of the investor money had been lost. My client didn’t invest, and his money was safe.
You probably already know that you have to make a profit when you sell, but how closely are you watching your gross margin? It’s the first benchmark of how successful your product is and it’s a strong indicator of how you’re doing as a business manager.
- The gross margin is calculated as: Sales price – (Cost of manufacture + Sales Cost)
- Or, another way to say it is: Sales price – Cost of Sales
Following are six strategies you can use to improve your gross margin, in order to put more money in your pocket. This is a critical part of the “Bootstrap, Don’t Borrow” philosophy. What can you do better so you don’t need to borrow?
Strategy #1: Know Your Numbers
You can control what you measure. If you don’t measure it, you can’t control it. Period. You need to know your numbers. That means you need to have accurate, consistent financial statements prepared on a regular and timely basis. It doesn’t do you a bit of good if your financial statements are months late. You need numbers that you can use now. A financial report tells you what is working, and what is not. Further, reports lead to activities.
#2: Increase Sales Price
Now that you know your gross margin, let’s assume you see it slipping, or else it is just not good enough. One simple answer may be to increase your sales price. An increase in sales price means an increase in gross margin. However, the number of sales may slip, so that needs to be watched as well.
#3: Increase Volume
As your volume of sales goes up, your volume of production goes up. Commonly, that also means your cost per unit goes down. There is a certain economy of scale, which means as you scale a business up, the overall costs go down. Your production gets more efficient, and you get better sourcing prices.
#4: Refine Product Mix
Unless you sell just one product or service, you have a product mix. That means you have multiple gross margin calculations. What are your most profitable items? How can you change your product-sold mix so that you sell more of those in relationship to other items?
#5: Review Sales Channels
Most people sell in more than one way. You may sell online, in a regular brick and mortar stores, wholesale, and/or retail. Take a look at your sales channels. Where is your best gross margin? What can you do to increase those sales?
#6: Improve Sales Regions
If you sell online, through multiple sales people or merchants, or through more than location, then you have sales regions. Where do you sell the most? Where do you make the most? What can you do to refine the regional sales, so you focus your attention where you make the most money?
Your gross margin is only one statistic to watch regularly for your business, but it is an important one. Without a good gross margin, you don’t have a sustainable business.