Sounds technical, and there is an element of accounting acronym that unfortunately I can’t get away from. My intention in this post is to attempt to take an arrangement of complex material and make it easy to comprehend.

By increasing your Gross Margin, you will at the same time increase your Profit and Cashflow:

For example

  • Say your current annual business revenue is currently $5 million
  • At a 30% Gross Margin, in $ terms, your Gross Margin is $1.5 million.
  • If your costs are $1m per annum, then your Profit per Annum is $0.5m before tax.

What would happen if your business increased its Gross Margin to 40%, and what would be the likely result?

  • Using the example above, a 40% Gross Margin on $5 million annual revenue is $2 million.
  • This is a $0.5 million increase in Gross Margin.
  • If you are like most businesses, between 70 and 80% of this $0.5 million Gross Margin would flow to the bottom line; that is, increase profit.
  • This would mean your $0.5million profit before tax would increase by another $0.4 million (assuming that 80% of the $0.5 million Gross Margin would flow into Profit.
  • Your Profit before Tax has therefore increased from $0.5 million to $0.9 million – an 80% increase.
  • If your business then collected 95% of this profit over time, then your business an additional $380,000 in cash to utilise over a year – i.e. $31,000 per month.

Why does 70-80% of an increase in a Gross Margin increase flow into Profit?

Because the costs that your business pays in arriving at Gross Margin are direct costs; incurred to produce the Gross Margin! This only leaves minor overhead costs (i.e. the 20-30% that does not flow to profit), resulting in the 70% – 80% profit increase.

How can you increase your Gross Margin?

  1. The first key is to focus on client value, rather than cost to produce.
  2. The second key is to understand at a deep level the benefits that your prospects and customers are looking for; both now, and benefits that you could deliver that they are not currently aware of.
  3. The third key, and probably the most critical is to ensure that you measure and manage your Gross Margin (at minimum monthly), so that you can then manage and measure the improvement in Gross Margin as you increase it.

If you are interested in better understanding how to increase your Gross Margin, then make contact.