Gross Vs. Net Margin Ep 247

Summary Notes


Speaker B, addressing small and medium business owners, underscores the critical distinction between gross and net margins, emphasizing their importance in assessing business health and investment potential. They explain that gross margin is the revenue minus the cost of goods sold, which for service businesses means payroll hours, not physical products. Speaker B advocates for a minimum 80% gross margin to ensure profitability and scalability, offering strategies to improve margins by reducing costs or increasing prices. They also highlight the common entrepreneurial hurdle of undercharging for services, which can impede profit and growth. Meanwhile, Speaker A briefly promotes their book, "100 Million Dollar Offers," as a resource for business success.

Summary Notes

Financial Struggles and Importance of Understanding Margins

  • Discusses the common problem of working hard all month but having nothing to show for it financially.
  • Introduces the concept of gross and net margins as essential for small and medium business owners.
  • Emphasizes that understanding margins is crucial for assessing business health and investment decisions.
  • Aims to clarify the difference between gross and net margins and provide practical advice for improving them.

"If you've ever struggled at the end of the month and worked all the way there to, only to look at the bank account and find that there was nothing there, there was too little for you to take out and then been like, I literally just worked for an entire month for nothing, then this video is for you."

The quote highlights the frustration of working hard yet not seeing financial results, setting the stage for the importance of understanding business margins.

Gross Margin Explained

  • Defines gross margin as the cost directly associated with fulfilling goods or services.
  • Simplifies the concept by stating that it is essentially revenue minus the cost of goods sold (COGS).
  • Clarifies that for service businesses, COGS includes the incremental cost of additional units, not fixed costs like rent or salaries for non-direct labor.

"Gross margin is what the direct cost of fulfilling your goods or services are."

This quote defines gross margin as the money left after subtracting the direct costs from revenue.

"It's the revenue. How much money you're making minus the cost of goods sold."

The quote provides the basic formula for calculating gross margin: revenue minus COGS.

"The cost of goods sold for a service business, which is what the majority of people who are listening to this are using, is the incremental cost of the additional unit, which means that that doesn't count your front desk girl, that doesn't count your HR director, it doesn't count your rent. None of that stuff counts. It's just the cost of one additional unit."

This quote explains that for service businesses, COGS pertains only to the direct costs associated with providing an additional unit of service, not fixed overhead costs.

Net Margin Defined

  • Describes net margin as the profit remaining after all expenses have been paid, including both direct and indirect costs.
  • Stresses that gross margin is critical as it leads to the creation of net margin.
  • Positions gross margin as the primary focus for fixing and improving a business's financial health.

"Your net margin is your chop, right? It's the juice at the end of the month. It's what you get after everything is paid, what's left over. That's what you end up taking home."

The quote defines net margin as the final profit a business owner takes home after all expenses are deducted from the revenue.

"The gross margin, in my opinion, well, they're both obviously very important, but the gross margin is the one that begets, that creates the net margin."

This quote emphasizes the significance of gross margin as the foundational profit from which net margin is derived.

Gross Margin Calculation Example

  • Provides a hypothetical scenario of a service sold for $60 per hour with a COGS of $20.
  • Illustrates the common misconception that the remaining $40 is pure profit.
  • Sets up the basis for understanding the gross margin calculation.

"So let's say we're selling a service for $60 per hour. Let's just say you're a hairstylist or you're a trainer. It doesn't matter, right? You're selling $60 in your business, and your cost of goods sold, let's say, is $20, right? You're paying somebody $20 for the $60 thing. You're like, that sounds good. There's $40 left over for me. This makes sense, right? Wrong."

The quote presents an example to illustrate the initial calculation of gross margin and foreshadows a common misunderstanding regarding the remaining balance after COGS.

Understanding Gross Margin

  • Gross margin is calculated by taking the leftover amount after costs from the revenue and dividing it by the gross revenue.
  • An example is provided with a $60 service charge and a $20 cost, resulting in a $40 leftover, which equates to a 66% gross margin.
  • Incremental increases in gross margin can significantly impact net margins and overall profitability.

Now, what you do to figure out your margins, you take that $40, what's left over, divided by the $60 of revenue, which is what you got gross. And what that does is it gets 66%. That's the gross margin.

This quote explains how to calculate the gross margin percentage, which is a fundamental concept in understanding business profitability.

The Importance of Gross Margin in Business

  • Gross margin is critical because it can drastically affect net margins at the end of the year.
  • A comparison is made between a business with 66% gross margins ending the year with 12% net margins and one with 80% gross margins ending with 26% net margins.
  • The speaker emphasizes that increasing the gross margin from 66% to 80% can more than double the net profit.

And so let me show you the difference. So let's say at the end of the year, you're running a business that runs on 66% gross margins. And let's say at the very end of the year now, we're in the net margin category, you end up with 12% margins.

This quote highlights the significant impact that gross margin percentages have on the final net margin of a business, demonstrating the importance of monitoring and optimizing gross margins.

Strategies to Increase Gross Margin

  • Gross margin can be increased either by reducing costs or by raising prices.
  • Decreasing the cost of service from $20 to $12 on a $60 charge increases the gross margin to 80%.
  • Alternatively, increasing the charge to $100 for a $20 cost service also achieves an 80% gross margin.

So if 80% gross margin is what I need, there's two ways I can do it. One, I can decrease this cost, right? I could say that I get this to $12. This becomes $12. So cross that out. And now my new take home on this is $48, right? And so $48 over 60 equals 80%.

This quote outlines the first method to increase gross margins, which is by reducing the cost of the service or product.

And so that means that you'd have to charge $100 for your $20 thing to have an 80% margin.

This quote explains the second method to increase gross margins, which involves raising the price of the service or product.

The Role of Gross Margin in Covering Business Expenses

  • A high gross margin is necessary to cover all other business expenses, including marketing and profit.
  • The speaker asserts that all successful businesses have very high gross margins, often around 99%.

Now from that $80, and here's what's important. You have to pay for everything else in the business and have enough money to market to acquire more customers, and you have to have enough money to have a profit, right?

This quote emphasizes the importance of a high gross margin to ensure there is enough money left after covering costs to pay for other business expenses and to make a profit.

Comparing Different Levels of Gross Margins

  • The difference between 80%, 90%, 95%, and even 100% gross margins is significant and can lead to much larger profits.
  • Even seemingly small increases in gross margin percentages can have a large impact on the business's financial health.

And so, by the way, all successful business, the biggest businesses in the world, they're not running 80% margins, they're running 99% gross margins, all right?

This quote indicates that the most successful businesses operate with extremely high gross margins, which allows them to cover costs effectively and maximize profits.

Understanding Profitability and Gross Margins

  • Profitability is significantly enhanced by improving gross margins.
  • A move from 80% to 90% gross margins effectively doubles profitability.
  • Higher gross margins allow for selling twice as many products or services for the same cost, which is crucial for scaling a business.
  • Entrepreneurs often struggle with charging more for their products or services due to a mental barrier regarding profit-making.

"Is that difference between 80 and 90 is that this is twice as profitable as this. Why? Because it's half the cost, right? It means I took that 20 and made it ten."

This quote explains the concept of gross margin improvement, where reducing costs from 20% to 10% effectively doubles profitability.

"The difference between 90 and 95% gross margins, again, twice as profitable. And what I mean by that is that you can sell twice as many people for the same cost. That is the magic. And that is how you scale."

The speaker emphasizes that a higher gross margin percentage enables a business to scale by serving more customers without increasing costs.

"But the thing is that if you do not do this, you will make no profit and you will not be able to scale."

This quote underlines the necessity of overcoming the mental barrier to charge appropriately and achieve high gross margins for business growth and scalability.

The Role of Cost of Acquisition

  • The cost of acquisition is a vital consideration in profitability and must be a sustainable percentage of revenue.
  • After accounting for the cost of acquisition, businesses must still cover other operational expenses like rent, payroll, and software from the remaining revenue.
  • A target of 80% gross margin is recommended, especially for service businesses, to maintain a healthy profit and allow for investment and growth.

"So if I have $80 left over, that means that it depends on what my cost of acquisition is. So let's say there's a certain percentage of my revenue that I'm willing to give for cost of acquisition. Let's say it's 20%, right?"

This quote introduces the concept of the cost of acquisition and its impact on the remaining funds available for other business expenses.

"And so, in sum, total here, if I'm looking at a business, the big number that I'm looking at is 80%. And that's what I target."

The speaker shares their personal benchmark for gross margins, suggesting that 80% is a strong target for maintaining profitability.

Strategies to Increase Gross Margins

  • There are two main strategies to increase gross margins: decreasing costs and increasing prices.
  • Increasing gross margin percentage is a powerful lever for improving the productivity and profitability of a business.
  • Understanding and analyzing one's gross margins is crucial for making informed decisions on pricing and cost management.

"And so the two ways you can do it, just as a quick recap to increase your gross margin, is, number one, you can decrease the cost, and number two, you can increase the price, and that is how you can increase your gross margin percentage."

This quote summarizes the strategies for increasing gross margins, which are fundamental for business success and financial health.

Promoting a Book as a Value Offering

  • The host promotes their book, "100 million Dollar Offers," as a valuable resource for the podcast community.
  • The book is positioned as a gift to the community and a means to establish a relationship with potential future business partners.
  • The offer of the book at a low price on Kindle is a strategic move to provide value and build goodwill.

"It's called 100 million Dollar Offers. At over 8005 star reviews, it has almost a perfect score. You can get it for ninety nine cents on Kindle."

This quote is part of the host's promotion, highlighting the book's high ratings and low cost as incentives for the audience to engage with the content.

Understanding Business Costs and Gross Margins

  • A business owner at a mastermind event is unsure of his company's gross margins.
  • The business involves coaching, where one coach handles multiple clients.
  • The owner pays the coach $4,000 per month.
  • The coach can handle 40 clients.
  • Clients are charged $1,200 for a package that covers three months, equating to $400 per month.
  • The owner's revenue from 40 clients is $16,000 per month.
  • After paying the coach, $12,000 remains, indicating a gross margin of 75%.

"So he was paying his coach $4,000 a month, all right? That's what he was paying his coach. And I said, cool. How many clients can your coach handle? He said, well, my coach can handle 40 people." "So $16,000 per month, and the cost of the coach is $4,000, right. Everyone following with me. So it means that there's $12,000 left over."

The quotes explain the calculation of the gross margin by subtracting the coach's cost from the monthly revenue and then dividing the remainder by the total revenue. This case illustrates how to assess and understand the cost structure of a business model.

Increasing Net Margins

  • A slight increase in net margins can significantly impact annual earnings.
  • Raising net margins from 15% to 20% equates to a 25% increase in profits.
  • Adjusting costs or prices can achieve higher net margins.
  • To reach an 80% gross margin, the business owner must either decrease the coach's salary or increase client charges.
  • An additional $20 charge per client or a reduction in the coach's salary to $3,200 would be needed to improve the gross margin from 75% to 80%.

"Bumping the extra five takes you to 20, right? And you're like, oh, wow, that doesn't seem like a big difference. 15% to 20% net margins at the end of the year is a 25% increase in how much money you make." "So that would mean that he has to get to $12,800 if he wanted to get over 80%, which means he either needs to charge the extra 40 clients an extra $20. No, $20. Yeah, he would need to charge an extra $20 here."

The quotes highlight the importance of small changes in net margins and provide a practical example of how to adjust pricing or costs to achieve desired financial outcomes. They demonstrate the strategic thinking involved in financial management and the impact of such decisions on profitability.

Importance of Financial Acumen in Business

  • Understanding and manipulating financial levers is crucial for business success.
  • Detailed knowledge of costs, revenue, and margins is necessary for informed decision-making.
  • The discussion emphasizes the value of financial literacy in improving business models and consulting.
  • The speaker expresses a desire to provide useful content and encourages feedback.

"This is the game. This is the stuff that I dive super deep into when I'm trying to fix a business model or I'm consulting with somebody." "So hope you found this useful. Hopefully you like this. Hopefully you thought this was awesome. And if you didn't, well, please tell me. I just want to make stuff that you guys find valuable."

These quotes encapsulate the speaker's commitment to educating others about the intricacies of financial management within a business context. They also reflect the speaker's dedication to creating valuable content for the audience and the importance of feedback for improvement.

What others are sharing

Go To Library

Want to Deciphr in private?
- It's completely free

Deciphr Now
Footer background
Crossed lines icon
Crossed lines icon
Crossed lines icon
Crossed lines icon
Crossed lines icon
Crossed lines icon
Crossed lines icon

© 2024 Deciphr

Terms and ConditionsPrivacy Policy