Gross Profit Margin: The Secret to Assessing your Company's true Profitability

Gross profit margin is an essential indicator for managing a company's profitability. Too often overlooked or misinterpreted, it is nevertheless a fundamental lever for understanding whether your business is healthy and capable of generating profits. Whether you are a craftsman, retailer, freelancer, or SME manager, a good understanding of gross profit margin will enable you to make more informed strategic decisions, particularly in terms of pricing, purchasing, and development.

Gross profit margin is the difference between revenue and the cost of sales, i.e., the expenses directly related to the production or purchase of the goods or services sold. It therefore reflects the value added generated by your business before fixed costs (salaries, rent, marketing, etc.) are taken into account.

Simple example: if you sell a product for $100 and it costs you $60 to produce or purchase, your gross margin is $40. This means that each sale leaves you $40 to cover your fixed costs and make a profit.

This is sometimes referred to as the gross margin ratio, which is expressed as a percentage: (Gross margin / Turnover) x 100. In our example, the gross margin ratio would be 40%. Understanding this concept is crucial for evaluating the performance of a business, but also for quickly detecting a decline in profitability or an increase in production costs.

Calculating gross profit margin is relatively simple, but it is important to distinguish between what is included in the cost of sales. The formula is as follows:Gross margin = Revenue - Cost of purchasing or producing the goods or services soldRevenue represents total sales excluding taxes. The cost of sales includes only costs that are directly attributable to production or purchase: raw materials, goods, subcontracting, manufacturing costs, etc. Indirect costs such as administrative salaries, marketing expenses, or rent should not be included

Concrete example:

• You are a textile company.

• You sell 500 T-shirts at $25 → Turnover = $12,500

• The production cost (fabric, printing, direct labor) is $7,000

• Gross margin = $12,500 - $7,000 = $5,500

• Gross margin rate = (5,500 / 12,500) x 100 = 44%

Monitoring this margin on a monthly or quarterly basis allows you to anticipate cost increases or decreases in profitability.

Gross profit margin is an excellent indicator of a company's operating profitability. It helps answer key questions:

• Is your business profitable from the moment of sale?

  If your gross margin is too low, you will struggle to cover your fixed costs.

• Are your selling prices high enough?

  If your margin is falling, you may need to reevaluate your prices.

• Are your purchasing or production costs under control?

  A sudden increase in costs can eat into your margin without any drop in revenue.

It is also used by investors and banks to assess the strength of a company. A high gross margin indicates an ability to generate value, a competitive advantage, or even an effective differentiation strategy.Finally, it is a key tool for optimizing your business model: you can adjust volumes, price positioning, or reduce costs to improve your profitability.

Gross margin should not be confused with net margin, even though the two indicators are complementary.

• Gross margin only takes into account costs directly related to the production or purchase of the products sold.

• Net margin, on the other hand, takes into account all of the company's expenses (fixed and variable), including salaries, rent, taxes, financial expenses, and depreciation.

Net margin formula: Net margin = Net income / Revenue In other words, net margin indicates the final profit that the company generates once all its expenses have been covered. It is therefore more comprehensive, but less immediately useful for managing day-to-day operations. Gross margin, on the other hand, allows you to act more quickly on prices, costs, or volumes.

There is no universal “ideal” gross profit margin: it all depends on the sector, the company's positioning, and its business model. Here are some indicative figures:

In high value-added sectors (services, tech, digital), margins are higher because variable costs are low. Conversely, retail and manufacturing businesses often have higher purchasing or production costs, which automatically reduces their gross margin. It is therefore crucial to compare yourself to your direct competitors or your own historical performance, rather than aiming for a generic rate.

Improving your gross profit margin does not simply mean increasing your prices. There are several levers you can pull depending on your business and market. Here are the main areas for optimization:

Start by analyzing all the elements that make up your purchase or production costs. Here are a few ideas:

• Negotiate with your suppliers to obtain better prices or favorable payment terms.

• Look for alternatives (cheaper raw materials, local manufacturing, more competitive subcontractors).

• Optimize production processes to reduce losses, waste, or downtime (lean management, automation, etc.).

• Manage inventory better to avoid overproduction or unsold items.

Every dollar saved on your costs translates directly into a higher gross margin.

Your selling price has a direct impact on your margin. Here are a few ideas:

• Move upmarket: offer a premium version of your product or service with higher added value.

• Provide more perceived value (packaging, warranties, related services) to justify a higher price.

• Segment your customer base: some customers are willing to pay more for a customized or express service.

Caution: any price increase must be in line with customer perception. Test, measure, and adjust gradually.

Sometimes, certain products or services are dragging down your margin. You can:

• Identify your most profitable offerings and highlight them.

• Discontinue low-margin or slow-moving products.

• Develop recurring or complementary offerings that build loyalty and increase customer value.

The idea is not necessarily to sell more, but to sell more intelligently.

Gross profit margin is much more than just an accounting figure. It is a powerful strategic management tool that helps you understand whether your business is creating value... or running out of steam. Controlling your gross margin helps you:

• Make a clear diagnosis of your profitability.

• Set prices and choose suppliers more effectively.

• Respond quickly to performance declines.

It is also an indicator that is closely scrutinized by investors, banks, and future partners. In short, measure it regularly, optimize it continuously, and base your decisions on concrete data. It is one of the best ways to ensure the health and sustainable growth of your business.

1. Should salaries be included in the calculation of gross profit margin? No. Only costs directly related to the production or purchase of goods or services are taken into account. Administrative, sales, and management salaries are excluded.

2. What is the difference between gross profit margin and profit? Gross profit is an intermediate result. Profit (or net income) is what remains after deducting all expenses (fixed, variable, taxes, depreciation, etc.).

3. Can a company have a positive gross profit margin but still be operating at a loss? Yes. A good gross margin indicates that you are selling at the right price or with good efficiency. But if your fixed costs are too high, you may still be operating at a loss.

4. How do I know if my gross profit margin is “good”? Compare yourself to your industry and your historical data. A sudden drop in margin is often a warning sign. There is no universal “right” figure.

5. Should I aim for a high gross profit margin at all costs? Not necessarily. A lower gross margin can be offset by high sales volume or excellent control of fixed costs. The important thing is to strike the right balance.