Why Gross Profit Margin Is the Most Vital Metric for Small Business

Understanding gross profit margin for privately held businesses

There are many ways of looking at a company’s financials. For example, operating profit, net profit margin, and return on assets. Although these are all important metrics in this article, we will break down why gross profit margin (GPM) is one of the most important figures for any privately held business. Gross profit is the amount a business earns after subtracting their cost of goods sold (COGS) from its revenue and is the first step in any P&L of a business, gross profit does not consider operating expenses, taxes, and other costs. GPM is like a team scoring efficiency, imagine a basketball team, scoring points is like generating revenue but scoring points isn’t enough to win games. What really matters is scoring efficiency which is just how well a team converts its shot into points relative to the number of opportunities. Just as coaches analyze shooting percentages to improve their team’s performance, business owners should track GPM to ensure they are making more profit per dollar of revenue. Without a strong GPM, even a high-scoring team (or high-revenue business) might not be winning in the long run.

The Role of Gross Profit Margin in Business Decision-Making

One factor that makes GPM such a great metric is its influence on different important decisions for privately held companies. One of these decisions is pricing, looking at your GPM can tell you a lot about pricing for example a strong GPM allows businesses to price products competitively while maintaining profitability. On the other hand, if your GPM is too low you might need to increase prices to improve profitability. Another great way to combat a low GPM is to negotiate better supplier contracts or look for alternative vendors, any decisions that affect your COGS will be vital when using GPM as your main metric. Another key component of GPM is that it enables a business to properly budget. Example, if your GPM is $200,000 annually you cannot budget for rent $20,000 a month. It can be said that budgeting begins with gross profit margin.

Gross Profit Margin as a Key Indicator of Business Health

Another way that GPM is incredibly useful is when looking at a business’s health. Looking at your GPM can give you important insight into whether your business is working effectively and efficiently. Tracking GPM over time is also incredibly important because a declining GPM means that your COGS are rising faster than your revenue if this is the case you should look to analyze material costs, labor, and production expenses to find areas to cut costs without sacrificing quality. Because of all these reasons investors and lenders will often use your GPM as a benchmark for your business adding yet another layer of importance to this number.

Conclusion

Gross profit margin is one of the most important business metrics because it helps you make important decisions about your business-like pricing and budgeting, additionally, it’s also an overriding factor long term when looking at your business’s health and growth. Making sure ways you can help achieve a healthy GPM. GPM is not just a financial metric—it directly influences how a business prices its products and controls costs. By tracking GPM, companies can make strategic adjustments to maintain profitability, improve efficiency, and stay competitive.

Alex Hart collaborated on the article with Andreas  Serfilippi.

Related content:

3 Insights on How Small Business Cost of Goods Sold Can Determine Profits