Gross Profit vs. Net Profit: The Truth Behind the Numbers
When it comes to gross profit versus net profit, it’s easy to fall into the trap of paying more attention to net profit as an indicator of business health. However, there’s a fundamental issue here, as net profit allows lies to sneak in.
What does this mean? When looking at gross profit, it’s a simple equation of revenue minus costs. There’s no hiding anything. You have to pay the payroll, the vendor, invoice clients, etc. It’s a crystal clear picture of the money coming and going within your business.
But once we start picking expenses off of our gross profit, that’s when the lies that we tend to tell ourselves are uncovered. For example, looking at G&A expenses and sifting through owners’ discretionary spending – kids’ tuition, vacations, and other large-item purchases. There’s no issue with putting such purchases through the company. But unless you’re consistently hitting a solid gross profit target to confirm that you’re operationally sound, the net profit you’re left with can be easily convoluted.
The way to ensure clarity is to ensure gross profit is consistently hitting a certain marker. When this is achieved, you’ll be much more equipped to make sound expense decisions while having a more accurate picture of your finances. So, what gross profit target is ideal for your business to thrive?
The Magic Number
After consultation with mathematicians, analysts, and MSP experts within our team, we’ve put the Gross Profit Margin (GPM) marker at 42%. Once you’ve determined your GPM, you can begin the process of identifying operational expenses such as sales expenses, G&A expenses, and so on.
Then–net profit. For example, at 42%, if you can contain your operational expenses to 25%, then you’ll achieve 17% net profit. Then, if you take a blended average of your different business lines of product, service, and resold cloud services, you need to deliver 42% gross profit across the three of those, not forgetting that you need gross profit targets for each as well.
The Gross Profit Target: Steps for Success
As with any business changes, it may seem daunting to implement new targets. But here’s the reality–taking on a 42% gross profit target requires just a few simple steps.
First, simply pull up a P&L. Here you’ll find a calculation of your gross profit to learn where you’re currently sitting. If you’re already consistently hitting 42%, kudos to you! Now dig deeper to understand why you’re hitting the target. Let your management team in on this. They need to understand the GPM target for each revenue line as well. That way, they can gain clarity on the things they should continue doing, or where changes should be made.
If, however, you find your gross profit is lower than 42%, start thinking about the levers you may be able to pull within the business to get closer to this target. To do this, it’s important to understand the nuances of reaching the blended average between revenue percentages from the different lines of business. What revenue percentage of each do they represent? What does the profit margin contribution from each of those lines represent?
Understanding Gross Profit Targets for Service and Sales Departments
It’s likely that your service manager maintains the largest revenue out of all your business lines, so it’s essential that they understand what their service department gross profit target should be, as well as all the levers necessary to impact it.
Next, your sales department needs to understand the gross profit margin for products. They’re likely going to be the second biggest revenue line, so there needs to be a strong gross profit target here as well – a minimum of 20%.
For the service department, aim for a minimum gross profit target of 55 percent. And for the resold cloud services, such as Microsoft licenses – Read our Blog on this here – or Backup-as-a-Service offerings from Datto, we suggest a target around 18 percent.
If you pay attention to this number at least once a month and consistently review it to ensure you’re making real progress, you’ll be better equipped to make informed decisions and keep your business in optimum health.
Like what you found here? There’s plenty more where that came from inside our peer team community. We regularly review gross profit, as well as 18 other key financial targets for MSPs, while sharing proven strategies to get there. Interested? Get in touch here for more information. You can even ask to speak with one of our team members about how BMK Community has changed the game for their business’s success.