Calculate Your Sales Price and Gross Profit Margin

If you sell more units of your product, your COGS also go up by the same percentage; as you now need to service more units of product.

Ideally, your Sales Price and COGS are in a fixed relationship so you can always know your gross profit margin. But in the real world, COGS shift from day to day, affecting our gross margin daily. We’re mostly just looking for averages.

Gross Profit must always be positive.

This is because if it’s negative, you’re selling your products at a loss!

The common things to include in your COGS are:

1. GST –
   • If you’re not registered for GST, then all of your COGS should include the GST – as it’s a real cost to you.
   • If you’re already GST registered, you should always calculate everything ‘Ex GST’ (both the sales in and the COGS out), as the COGS GST reduces the Sales GST you owe, and neutralizes itself.
2. Credit Card expense (as it’s directly tied to the unit’s pricing).
3. Labour – When it’s directly related to servicing that product or service only. If it’s not directly related, labour would go into your ‘fixed costs’.
4. Materials – When it’s directly linked to the product.
5. Packaging
6. Shipping Costs
7. And Others.

What does ‘directly linked’ mean?

Some costs are easy to relate directly to a sale. “I sold 1 tool. I had to pay for the tool, package it, and ship it.“

But some costs are not so easy to relate to a sale.

Many businesses have staff that do multiple things at once, and they use bulk packaging that will be used for many products in different amounts. You may find that you have the same staff cost for selling 3 units vs 5 units. In this way – they’re not directly linked.

If you can’t perfectly split out the direct costs of the product, you need to decide if you want to estimate and include in COGS, or whether they belong in operating expenses instead.

When you’re doing your planning, it’s useful to split these things into direct costs wherever possible to get a strong sense of margins. But when it’s time to run your business, the Accountant will have a much stricter set of rules for what you can call COGS, and a lot of things will end up in ‘operating expenses’ instead.

And Now Net Profit? No! EBIT!

Hold your horses! The next line we’ll get to is EBIT. This stands for ‘Earnings Before Interest and Taxes’.

EBIT is your Sales minus your costs of goods sold; and then also minus your operating expenses. So we take our gross profit from above, and we deduct:

1. Admin costs.
2. Cleaning costs.
3. Rent.
4. Electricity, Water, Sewer Rates
5. Depreciation of your equipment.
6. And every other operating cost except for Interest and Tax.

Your business’ EBIT is a pretty good way to think about your business’s actual profitability. A strong EBIT is an indicator that your business is healthy. Usually if you can keep a high gross profit margin, and sell lots of products or services, you’ll be able to overcome your fixed operating expenses to post a good EBIT.

But having a high gross profit margin is not enough. If you have a great Gross Profit Margin, but don’t sell enough products, you won’t be able to cover your fixed operating expenses, and your EBIT won’t be positive!

Net Profit… Finally!

Finally once we’ve got our EBIT, we need to deduct any loan interest and taxes we owe to the government (Think: end of year tax on your profits).

If you’re a Sole Trader, your EBIT is essentially your Gross Salary, and your Net Profit is essentially your Net Salary.

Do I Need to Change my Pricing When I Register for GST?

Yes. When you register for GST, you’ll be passing the government extra money from the customer, so it’s important that you don’t try to ‘absorb’ the GST into your old pricing scheme.

Make sure to do a new gross profit calculation when you register for GST, and aim for the same Gross Profit Margin or better.

Back to the Calculator: A Good Gross Profit is Step 1

As you can see, we:

1. Start with a Sales Price and Cost of Goods Sold
2. We move onto a Gross Profit Margin and an Overall Gross Profit
3. We then deduct our operating expenses to find our EBIT.
4. We then deduct our Interest and Income Tax to find our Net Profit.

So step 1 in your products and services journey is to ensure that your Gross Profit Margin is strong so that you don’t need to sell many units to overcome your operating expenses.