Gross Profit Margin
A common question business owners want answered is: how do I know if I'm making enough profit to stay open? In our previous post, we talked about average order value, which can directly feed into profits, but one metric that can help answer this larger question is your gross profit margin.
Gross Profit Margin ExplainedThe gross profit margin measures how much money you're making after the costs of goods sold (parts and labor) is subtracted. To calculate: (Revenue – Costs of goods sold) / Revenue. For example, if a shop brings in $1,500,000 of total revenue, but the costs of goods sold is $450,000, then their gross profit margin is 70%.
By monitoring the gross profit margin (usually calculated as a percent) instead of just gross profit, you're better able to track trends in your profits.
Depending on how you want to plan for the future of the shop, the gross profit margin can be broken down by different time frames (week, month, year, etc.) if you're wanting to evaluate the overall profitability, or by job, if you want to see how profitable different types of jobs are. The latter allows you to pinpoint exactly where you might be losing money, while the former focuses more on the big picture.
Why Bother Tracking Your Gross Profit Margin
Like the other KPIs we recommend monitoring, the gross profit margin can tell you several important things. First, it lets you know if you're making enough money in sales to cover your costs. If you're not, it's a good sign that you might need to reevaluate your pricing structure.
It also tells you just how profitable your company is. The higher the gross profit margin, the more profitable a company. Similarly, the gross profit margin allows you to better spot trends in your profitability. You can begin to notice when or where you don't seem to be making as much money and develop a plan to address it.
What Can be Done to Raise the Gross Profit Margin?
There are several different approaches you could try to help raise your gross profit margin, each with its own advantages and disadvantages.
Increase the Price of Parts
This seems like it would be the most obvious solution—increase your parts markup to maximize the amount of money you make on each job. It's true that you don't want to be losing money on parts, so it's important that you're charging the customer at least as much as you paid, if not a little more, to help your own profits.
You should note that there is always a danger in raising your prices. You run the risk of driving away customers if prices rise too much, defeating the purpose of raising them in the first place. Make sure that your prices are still competitive enough to keep customers from taking their business down the street.
Increase Billable Hours
By increasing the numbers of hours sold, you're again increasing the amount of money brought into the shop without incurring any additional costs. It runs a similar risk to raising prices on parts, though. You never want to charge a customer so much that they feel taken advantage of. It won't end up increasing your profits in the long run.
By decreasing the costs of goods sold, you're able to raise the gross profit margin while eliminating the risk of alienating the customer. There are several ways you could reduce costs.
First, you could increase the productivity and efficiency of your technicians. Make sure their time is being used to its maximum potential. Don't lose money due to inefficient systems. We'll discuss how to increase productivity and efficiency in later posts.
You could also try to decrease the amount you spend on parts. Make sure you're getting the best value by shopping around parts suppliers. Ask about discounts for buying in bulk or if they have any sort of preferred pricing (HHP does!). If you purchase only OEM parts, you could look into quality aftermarket options that cost you less but are made to the same standards as OEMs.
Things to Consider
While the gross profit margin does provide a good look at the profitability of you shop, keep in mind that the calculation doesn't include any overhead costs. This means that when looking at the overall profitability, you need to keep these costs in mind—it might seem like you're making a profit based on the gross profit margin, but you also need to make sure you're earning enough money to cover operating costs, non-technician salaries and benefits, taxes, etc.
In our next couple of posts, we'll go even more in depth on the gross profit margin, looking at two different aspects of it you can measure: gross profit margin on parts and gross profit margin on labor.
If you're interested in improving your gross profit margin, be sure to check out our Repair Shop Value Program. You can get exclusive pricing and other benefits that can help improve your shop's bottom line!