I know it seems like I’m constantly banging on about Cash flow and Gross Margin and that would probably be because I am. Healthy margins and cash flow almost always result in strong businesses that are geared for growth. This is what you should aim to be and hopefully our tips and blog posts are getting you one step closer to this.
To give you some context, we recently conducted a detailed margin review for a client who had experienced a decline in profit despite sales and overhead expenses tracking along as forecasted.
When setting the price point for their products, they calculated that they’d have a 55-60% gross margin (or 40% material costs), approx. 40% in overhead expenses and a net profit margin of approx. 20%. Good healthy financial results, which would result in a self-sustainable business that was cash flow positive and had the ability to invest in further research and development (R&D), whilst continue to aggressively advertise and promote their existing product range.
On paper the forecasts looked great. They were well thought out and appeared to be based on sound calculations. However 6 months into the financial year, things were not running to plan. Sales were strong, with many of their growth projections being met, however gross margin was tracking well below expectation. Instead to tracking along at 60%, the actual gross margin was only 45%. With 40% in overhead expenses, net profit before tax only represented 5% of total sales.