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Gross margin 101

In a previous post about cash flow management, I highlighted that gross margin is a key element for a sound and healthy cash flow.

What is the gross margin?

Gross Margin is the difference between Sales and COGS and represents the value added that your business is bringing.

Sales – COGS = Gross Margin 

The gross margin ( GM ) can be expressed as an absolute number or as a % from sales.

Why is gross margin important?

The GM is the balloon of air that allows you to breathe, that allows you to be up and running also the next day.

Out of the GM, you have to finance the indirect / support services that assure that your business is working as it should.

After the financing of the support, the remaining is called gross profit that is your cushion for the next business period.

What if I have a positive gross margin?

The positive gross margin shows that your business is producing value-added and makes sure that your company is “making money” at the operational level.

What if I have a negative gross margin?

Your negative gross margin is a bad thing, it shows that

1. your sales prices are much too small and do not cover your operational costs

or

    2.  your operational costs ( COGS ) are too high and you are making losses

A negative gross margin means that you have to get somewhere money ( cash flow management + proper financing )  to continue your business operations.

A too long period of negative gross margin means that you are making losses and losing money. Your operational business processes are not optimal, your business set up needs immediate attention and help.

What can I do?

A positive gross margin shows that currently, you are on the right track. You need to constantly watch your sales and cogs for any deviations and take corrective actions.

The GM analysis is of high importance for a successful business. If you manage your gross margin successfully you’ll have proper working operational processes and you’re making positive operational results.

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