How To Increase Gross Profit – Business Turnaround Tips
Welcome to the latest in our ‘Business Turnaround Tips’ series. When it comes to business success or business turnaround, sound commerciality is crucial. One of the best ways to improve the business’ numbers is to look at how to increase gross profit. In today’s post, I am going to show you how to increase your gross profit in 2 very simple ways. In addition to this post, I thoroughly recommend you read my guide on the Profit and Loss statement.
What is Gross Profit
Gross profit appears on the Profit and Loss statement (P&L). Here’s an example of the top of a typical P&L.
| Turnover | £100,000 |
| Cost of Sale | £50,000 |
| Gross Profit | £50,000 |
| Gross Margin | 50% |
As you can see, the turnover (sales) are £100,000. The cost of sale (the costs of materials, ingredients, packaging, etc) is £50,000. Therefore your gross profit (GP) is the difference. The Gross margin (GP Margin) is the gross profit as a percentage. Here’s the formula for how to calculate gross profit:
GROSS PROFIT = Turnover - Cost of Sale
How To Increase Gross Profit – 2 Options
When looking at how to increase gross profit, I like to keep it simple. There are lots of blogs out there which give you 10 ways to do this but it’s all largely waffle. I like to keep it simple. From the above formula, you can see that 2 things relate to your gross profit:
- Turnover
- Cost of Sales
Therefore you have 2 options to increase your gross profit:
- Increase Turnover
- Decrease Cost of Sale
If you increase your turnover and simultaneously decrease your cost of sale then you will increase your gross profit. By using the example above, let’s play around with some figures.
Increase Turnover
This was the original picture we used in the example above. We had a turnover of £100K, our cost of sale was £50K, therefore our gross profit was £50K.
| Turnover | £100,000 |
| Cost of Sale | £50,000 |
| Gross Profit | £50,000 |
| Gross Margin | 50% |
Now let’s look at what happens to the gross profit when we increase the turnover and keep the cost of sale the same.
| Turnover | £120,000 |
| Cost of Sale | £50,000 |
| Gross Profit | £70,000 |
| Gross Margin | 58.33% |
By just increasing the turnover, we have managed to increase the GP from £50K to £70K. As a percentage, the gross margin has now gone up from 50% to 58.33%. Good result!
So your first option is quite simply to increase your turnover (sales). Depending on your business you can increase sales by doing many things like:
- Get more customers
- Fire bad customers
- Focus on the customers that make up the majority of your turnover
- Get better Salespeople
- Try different Sales channels (social media, email marketing, face-to-face, free trials etc)
As this is a financial post, I want to focus mostly on the financials.
Improve your commerciality with this quick reference guide for all 3 financial statements. Learn the purpose of each statement, what numbers to look out for and they key questions you should ask when looking at them.
Decrease Cost of Sale
The cost of sale is anything you spend to make a sale. So if you’re selling a physical product, your cost of sale would include things like packaging, materials, printing costs, manufacturing etc. If you are selling a service, then your cost of sale might be your marketing budget (Facebook ads, email marketing costs etc).
Sticking to the same example, let’s see what happens when we keep the turnover as it was originally (£100K) and decrease the cost of sale.
| Turnover | £100,000 |
| Cost of Sale | £30,000 |
| Gross Profit | £70,000 |
| Gross Margin | 70% |
By decreasing our cost of sale from £50K to £30K we have increased the GP by £20K (£70K total!). Now that is a good GP!
How do you decrease the cost of sale?
- Negotiate hard with all your suppliers
- Change suppliers
- Change materials/ingredients
- Cut out unnecessary costs (expensive finishes on packaging, paying for software that you don’t use etc.)
Do Both – Increase Turnover and Decrease Cost of Sale
Now, let’s see what happens when we do both. Are you ready? Let’s go!
| Turnover | £120,000 |
| Cost of Sale | £30,000 |
| Gross Profit | £90,000 |
| Gross Margin | 75% |
Wow! Look at that GP! By doing both, we have now massively increased the gross profit from its original 50% to 75%! It bodes well for any business to do both.
There you have it! 2 very simple and easy ways on how to increase gross profit. For more information on the P&L, please check out my Profit and Loss 101. I hope you’ve enjoyed this part of our ‘Business Turnaround Tips’ series.
RECOMMENDED READING – Finance for Nonfinancial Managers by Gene Siciliano
