What is Gross Profit? What is Net Profit? Why is it Important to Understand?#
For a company to make money, the key is that the products sold have profit.
As long as the gross profit per item multiplied by the sales volume is greater than the operating costs, the company is making money.
- Increase the gross profit margin of each product;
- Expand the sales volume of the products.
In simple terms, it means selling at a higher price and selling more.
Formula 1: Revenue - Direct Costs = Gross Profit.
Direct costs refer to variable costs.
For example, a supermarket purchases Coca-Cola at 3 yuan and sells it at 5 yuan.
Gross Profit is the selling price minus the purchase price = 2 yuan.
Is this 2 yuan what the owner can ultimately take home? No.
Because indirect costs such as utilities, rent, and labor costs also need to be considered.
Gross profit refers to the profit before deducting expenses like office rent and management salaries.
Net profit is the gross profit minus indirect costs.
Formula 2: Gross Profit - Indirect Costs = Net Profit
Indirect costs refer to fixed costs.
Gross profit can determine the market competitiveness of a product;
Net profit can assess the management efficiency of a company.
This leads to the calculation formulas for Gross Profit Margin and Net Profit Margin.
Formula 3: Gross Profit / Revenue = Gross Profit Margin
Formula 4: Net Profit / Revenue = Net Profit Margin
The higher the gross profit margin, the more competitive the product is in the market, the more pricing power the company has, and the stronger the company's ability to create "added value."
Added value includes: brand value, technology patents, monopolies, region-specific resources, etc.
When choosing a gross profit-based product model, it is necessary to confirm whether the brand premium supporting this price has been accepted by consumers. For example, the gross profit margin of Moutai is 91.61%.
Net profit margin indicates how much net profit a company can earn from every dollar of revenue. It is also a static indicator to assess the management capability of the company's management team; only good management can save more profits for the company and shareholders.
What is the use of knowing this?
1. Pricing Products#
If a product has a purchase price of 100 yuan and you want to achieve a gross profit margin of 20% (different industries have reference values for gross profit margins), how should you price it?
Formula 5: Selling Price = Cost / Cost Rate = Variable Cost / (1 - Gross Profit Margin)
So the price is (100 / 0.8) = 125 yuan.
2. Calculate the "Break-even Point"#
The break-even point, also known as the breakeven point, refers to the product at which total revenue equals total costs, meaning the profit is zero at this point.
If sales revenue is above the break-even point, the company makes money; otherwise, it loses money.
For example, Aunt Li sells pancakes at the entrance of a middle school. The daily stall fee is 100 yuan, and the selling price of the pancakes is 5 yuan, with a cost of 3 yuan.
How many pancakes does Aunt Li need to sell daily to break even?
This problem is easy to calculate; first, calculate the gross profit as 2 yuan (selling price 5 yuan - cost 3 yuan);
The 100 yuan stall fee is a fixed cost (indirect cost);
So Aunt Li needs to sell at least 50 pancakes (fixed cost / gross profit) daily to break even.
But what if Aunt Li sells various pancake sets? In this case, you cannot simply calculate the sales volume.
Formula 6: Break-even Sales Volume = Fixed Cost / Gross Profit Margin
Gross Profit Margin = Gross Profit / Revenue = 2 / 5 = 40%
Break-even Point = 100 / 40% = 250 yuan
That is, Aunt Li needs to earn more than 250 yuan daily to break even.
The break-even point is derived from "fixed costs." If Zhang San sells flowers at the mall on Valentine's Day, there is no stall fee or other fixed costs, so there is no break-even point.
Extension: Generally, the restaurant industry uses revenue as a measure, and the minimum requirement for store revenue is to reach the break-even point.
3. Calculate How Much to Sell Monthly to Break Even#
If a product has a purchase price of 100 yuan, a selling price of 160 yuan, and monthly shop rent of 10,000 yuan, labor costs of 10,000 yuan, and utility costs of 2,500 yuan, how much must be sold monthly to break even?
- First, calculate the gross profit margin = (160 - 100) / 160 = 37.5%;
- Calculate fixed costs = 10,000 + 10,000 + 2,500 = 22,500 yuan;
- Calculate the break-even point = Fixed Costs / Gross Profit Margin = 22,500 / 37.5% = 60,000
That is, at least 60,000 must be sold each month to break even.
Here’s an extension: during the Spring Festival, many friends think that setting up a stall is very profitable, so they are eager to try it, but in the end, they not only fail to make money but also lose money. Here are a few thoughts I’d like to share:
1) Understand the gross profit margin of the products you sell;
If the gross profit margin is fixed and you know the cost, you can calculate the selling price.
If you determine the cost of the product and set the price independently (without competition), you can calculate the gross profit margin.
For example, if a toy gun has a purchase price of 20 yuan and a selling price of 50 yuan, the gross profit margin is 60%;
2) Understand the stall fee as fixed costs (e.g., 200 yuan daily);
3) Calculate the break-even point, which is 334 yuan.
That is, at least 334 yuan in revenue daily is needed to avoid losses.
4) Then apply the universal formula: Sales = Traffic * Conversion Rate * Average Transaction Value * Repurchase Rate
Traffic: The number of potential customers entering the sales funnel;
Traffic Cost: The average price to acquire a potential customer from each channel = Sales Cost / Number of Potential Customers;
Sales = Effective Traffic (Traffic * Conversion Rate) * Average Transaction Value
5) Understand how large the customer flow is and how many people will buy your product (i.e., market demand)
Only by integrating all this can you know whether this business is profitable.
4. Calculate How Much to Sell Monthly to Recover Investment
If the above store invested 150,000 and wants to recover the investment in 6 months, how much must be sold each month?
Formula 7: Monthly Revenue to Recover Investment = (Monthly Net Profit + Fixed Costs) / Gross Profit Margin
150 (thousand) / 6 = 25,000 yuan (net profit), meaning these net profits must be achieved each month.
Monthly Revenue to Recover Investment = (25,000 + 22,500) / 37.5% = 126,666.667
That is, at least 127,000 yuan in revenue must be achieved each month to recover the investment.