The Dr. is In: Moneyball!
Gross Margin by Job
Once you determine the gross profit for each job, turn that dollar number into a percentage. Take the gross profit and divide it by the total sales to determine the gross margin. This is important because it allows you to compare jobs of different sizes. A $25,000 job that produces a gross profit of $10,000 is a 40 percent margin. Compare that to a $40,000 job that produced a gross profit of $14,000. While the additional $4,000 of gross profit may seem like a good thing, the gross margin is only 35 percent. Was the additional effort of managing a larger job actually worth it?
Gross Profit and Gross Margin—Company-wide
Besides analyzing each job, look at your company as a whole. What often happens is that there are other costs hiding in the Cost of Goods Sold (COGS) section of your P&L, such as warranty costs.
If that’s the case, you may find that even though your individual jobs are producing an acceptable gross margin, when rolled up into your P&L, the gross margin is substantially less. If this is the case, you want to review all the costs sitting in your COGS section to make sure they’re specific to the jobs you’re currently producing.
Overhead as a Percentage
While reviewing your financials, look at your overhead as a percentage of your sales. Overhead should be relatively fixed, meaning that it doesn’t substantially fluctuate with volume.
Therefore, if your volume was consistent, your overhead should also be consistent. If your volume increases over time (assuming that you don’t have any significant changes to overhead in response to the increased volume), your overhead as a percentage of your sales should decrease. If this is not the case, you may have job-specific costs hiding in your overhead.
Markup vs. Margin
The percentages discussed above are all based on your total sales, and therefore referred to as margin numbers. Do not confuse these percentages with markup numbers. Markups are a percentage of costs; if you purchase a piece of equipment and mark it up a given percentage, you are multiplying the cost times a percent.
When you look at your P&L and see that overhead is 30 percent, don’t assume that since you mark everything up 40 percent, you’ll make money. A markup of 40% (based on costs) will produce a margin of less than 29% (based on sales) and therefore, not be enough to cover your overhead.