Why is Getting the Right Gross Margin so Important?
While there are many financial pieces to business success, your company’s Gross Margin remains one of the most critical pieces. It requires a keen understanding of its importance, and the necessary focus to arrive at the desired levels.
THIS IS A REALLY IMPORTANT NUMBER!
If your Gross Margin isn’t the right number it will be difficult — if not impossible —
to make a fair and reasonable net profit. Yes, it’s that important.
- Understanding exactly what Gross Margin is
- Learn how critical Gross Margin is to the financial success of your organization
- Know what Gross Margin is needed by % and $ to break even AND to make a profit
What is Gross Margin?
Gross Margin is basically what remains after you have paid for your labor plus burden (taxes, insurances, benefits etc.,) and material costs. Simply stated, Gross Margin is:
Revenue – Direct Costs = Gross Margin or Gross Profit
Direct Costs = Field Labor + Burden + Materials
Field Labor: Usually includes employees from the foremen level and below
Burden Costs Include:
- Payroll Taxes
- SUI- State Unemployment Insurance
- FUI- Federal Unemployment Insurance
- FICA- Federal Insurance Contributions Act or Social Security and Medicare
- Workers Comp Insurance as applied to these workers
- General Liability Insurance
- Medical Insurance costs for this level of employees
- Other Benefits
- Retirement benefits paid by the employer for this level of employees like IRA or 401K plans.
Burden Rate Ranges:
The burden rate usually ranges from 12% to 25% of payroll depending on what state you work in, your WC mod rate and what benefits you are paying for this level of employees.
Materials Costs Include: Applied materials to the job, chemicals, fertilizers, mulch, flowers, plants etc.
Note: Direct costs usually do not include supervision, gas, small tools, dump fees for maintenance, normal equipment used, and vacations or holidays. These are normally considered indirect costs. Subcontractor revenue and costs are also not normally figured into the Gross Margin equation.
Why is Gross Margin So Important?
Gross Margin is so critical because if there is not enough left over after the direct costs are paid out then you will not be able to pay for your overhead costs and profit. You are out of money! Not a good place to be.
One of the first steps to an organization’s financial health is to generate the right levels of Gross Margin to make money! Remember that Gross Margin serves as the “financial furnace” that keeps your organization “fiscally fit and warm.”
What Gross Margin is Needed to Breakeven? Or, to Make a Profit?
What is your overall combined Gross Margin now?
If you don’t know what your Gross Margin is, now is a great time to find out! Take your total revenue (less revenue from subcontracted work), and then subtract your direct costs. You now have your gross margin dollars. Divide this by the revenue and you have your Gross Margin percentage.
What is your total Gross Margin in dollars? $ ____________
What is your total Gross Margin as a percentage of revenue? _________%
Do you have enough total Gross Margin to cover your overhead expenses and make a fair and reasonable net profit?
Action Step: Determine if your Gross Margin is enough to cover your overhead expenses (breakeven point) It’s essential to know what this is!
Do you know what your Gross Margin is per revenue stream? Or, is your Gross Margin a blended combined number?
Action Step: Work toward getting your revenue streams broken out by both revenue and by Gross Margins for each revenue stream that represents 10 percent of your total revenue or greater. Next, determine your gross margin dollars and percentage per revenue stream.
Determine the Gross Margin – both % and $ — that is needed to cover your overhead and make a 5% net profit? Or, a 10% net profit?
Once you know what your Gross Margin % and $ that are needed you will have a great starting point for building a profitable company
When you’ve accomplished this, you will have some really SMART, not to mention really Gross Goals! Gross Margin Goals, that is.
Ed Laflamme LIC & Bill Arman