Are you wondering how to calculate gross profit margins for e-commerce products? Our handy guide will tell you everything you need to know to make informed accounting decisions.
It doesn’t matter how high your sales figure is; if your profit margins aren’t significant enough, your e-commerce business will never bloom. By calculating your gross profit margins for your e-commerce store, you will have a clearer picture of your business’s current position and its future.
Why you need to calculate your gross profit margin
Calculating your gross profit margin shows a clear percentage of revenue you retain after accounting for costs of goods sold. It is a common and versatile method to measure the basic profitability of your e-commerce business.
In layman’s terms, it communicates how much money you make each time you sell an item. If your gross profit is insufficient, you will likely run into an overall loss once all costs are accounted for. If you have an overall loss but a gross profit margin then your operating costs must be reduced, or your gross profitability raised to cover it.
By calculating your gross profit margin per item sold, you can ascertain how many sales are needed to bring home a certain level of income, to cover all additional business costs, or to allow you to invest in an additional goal.
Gross profit margin can also be an indicator of cash flow, but this is an area that requires extra scrutiny. Cash flow can make or break a fledgling business so please, take heed.
How to calculate gross profit margin for e-commerce items
Gross profit margins for e-commerce entrepreneurs are one of the key metrics and a great indicator of the viability of your business. It is the profit you make on each item. You can calculate it like this:
Revenue – Cost of Goods Sold (CoGS) = Gross profit margin
Your COGS are likely to include e-commerce platform fees, storage, and postage. This is anything that directly relates to the cost of selling that item. Costs such as marketing, staff or outsourcing costs, or accountancy fees are costs of doing business but not directly related to the sale of your item so cannot be included.
How to communicate your gross profit margin
Your gross profit margin, e-commerce entrepreneur or not, is a pivotal piece of information that you will only want to share with stakeholders, business partners and your accountant. It is usually written as a percentage.
(Gross profit margin / Revenue) x 100 = X%
Understanding your gross profit margin
Once you have your gross profit margin, all additional business costs will need to be deducted before you have your net profit margin, which is paid to you or retained by the business.
If your gross profit margin is low, you will need to make more sales to enable your costs to be met and profits to be paid out.
You can raise your gross profit margin by reducing your CoGS, often achieved by economies of scale or outsourcing, or increasing your revenue, often achieved by positioning the product as a premium item. Gently massage these figures to the sweet spot where customers are buying readily and happy with their service.
Factors to consider when reading your gross profit margin
E-commerce is a highly competitive market and often, the most successful businesses have surprisingly small gross profit margins. E-commerce businesses tend to have incredibly low overheads and thrive on a high level of sales. If you are selling something more bespoke and unique, it warrants a higher price point and a higher gross profit margin but if you are selling (or trying to sell) a large number of small-ticket items, then competitiveness in the marketplace will often dictate your price point, and, as such, your gross profit margin.
If this is the case, look at ways to downsize your fixed costs and other ways to stand out in the marketplace that will reduce the need for highly competitive pricing.
Comparing gross profit margins – e-commerce and beyond
No two businesses are the same and their gross profit margins won’t be either. You may be trying to compare your gross profit margin to that of a previous business you have owned, a brick-and-mortar store or even an e-commerce store in a different niche but be aware that you are unlikely to receive useful information through this approach.
E-commerce stores vary wildly in their reported gross profit margins with surveys suggesting it can be anywhere from 20-60%. Banking gross profit margins are as high as 51.8%, while manufacturing is as low as 8.5%.
If you would like to discuss ways to increase your gross profit margin or any other aspect of e-commerce accounting, our team is here to help. We specialise in e-commerce accounting and help entrepreneurs like you take their business to the next level.
The best time to act is now.