How to Maintain Gross Profit Margins
Gross profit margin is a metric that helps to assess efficiency in running a business. While overall costs influence the net profit margin, variable costs are a specific determinant of gross profit margin. Variable costs are the cost of goods sold -- for instance labor costs or material costs -- and are different from fixed operating costs of running a business. A greater control on variable costs results in higher gross profit margin and, therefore, in a more profitable business.
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Instructions
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Calculate gross profit margin. Subtract the cost of goods from overall sales, which results in gross profit, then divide gross profit by overall sales to get gross profit margin. In equation form this is written as gross profit margin = (total sales - cost of goods sold) / (total sales). For example, if a company registers gross sales of $500,000 in a year and the cost of goods sold amounts to $200,000 The gross profit margin = ($500,000 - $200,000)/($500,000), which is 0.6 or 60 percent.
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Compare the company's gross profit margin with the industry standards. If the margin is higher or on par with the industry standards, it probably suggests the variables costs of the business are under control. However, if the margin is lower than the industry average, it suggests a need for business corrections.
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Lower the variable costs. One way to maintain the gross profit margin is to lower the costs of goods sold. Depending on the nature of the business, volume discounts from a single supplier or finding a less costly supplier, or investing in technology to lower labor costs are some ways to control variable costs. However, inconsiderate cost control measures can damage the quality of products being sold. Revisiting the example used in Step 1, if 80 percent is the industry average and the company's current gross profit margin is 60 percent, to keep up with the industry standards -- the per unit selling price remaining constant -- the company has to lower the cost of goods sold from $200,000 to $100,000.
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Increase the prices. Another way to maintain the gross profit margin is to increase the prices of goods sold. Price increases require a careful reading of inflation rates, market competition and analysis of product supply and demand. An arbitrary increase in prices can cause sales to drop and a slump in overall gross profit required to run a business. Again, revisiting the example used in Step 1 -- the variable costs remaining constant -- the company has to increase its total sales from $500,000 to $600,000 or a 20 percent per unit price hike to increase the gross profit margin to the industry levels.
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Find the right balance between lowering costs and hiking prices. A business must lower variable costs to the point where the cost control measures do not compromise with the quality of the product being sold. The idea here is to take all necessary measures to reduce variable costs and let a price increase be the last resort to maintain the gross profit margin on par or above the industry average.
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