The Golden Ratio of % Gross Profit
When I meet with new clients I ask them to complete a questionnaire to assess how they feel about all aspects of the business. The aspect of their businesses that the owners consistently say they struggle with is the financial management of their businesses. I do find that most business owners, especially those who have been in business for a few years, know far more than they give themselves credit for.
So, what should a business owner focus on to see if the business is financially performing well?
The first area I focus on is whether the business is profitable. That is, the income from sales less all costs is enough to service the debts the business carries and pay the owners enough to live.
The greatest single contributor to this is what I believe is the golden ratio in any business – the % Gross Profit (%GP). The Gross Profit (Sales minus Cost of Sales) expressed as a percentage of Sales. If this is not trending at a consistently high enough level, your business will be in trouble – no matter what else you do.
What most business owners get wrong in calculating their %GP is the cost of sales. This should include:
- all materials purchased to complete jobs,
- the subcontractors required for the jobs and, most critically,
- the cost of internal labour to complete the jobs.
Each industry I work in has different %GPs, which are dictated by the labour and material costs in that industry and the competition which dictates the prices businesses can charge. If I’m reviewing a business and their %GP is too low relative to the industry there is something wrong.
So, if you do nothing else in assessing the financial performance of your business at least calculate and trend your %GP – the GOLDEN RATIO.
By Bob Weir, July 2018