Gross (Eww!) Profit

“Gross profit? What’s wrong with my profit? What’s gross about it?”

These are some questions I’ve heard before regarding the term “gross profit.”

And I can’t say I’d blame anyone without an accounting or finance background for asking these questions. The only problem here is that gross profit is one of the most important terms/metrics for a business of any size! It can help measure the overall health of your business; it can help determine future performance; heck, it can even lead to the demise of your company if not kept in check…

So, what exactly is gross profit? Let’s start with a good ol’ fashioned textbook definition: gross profit is total revenue minus the cost to produce that revenue. If that doesn’t help, here is gross profit calculated in the form of a few different examples:

 

  • If you sell a physical product – You sell a shirt for $20 and it costs you $8 to make the shirt. Your gross profit for one shirt is $12 ($20 revenue less $8 cost of goods sold). You’d do the same calculation if you bought the shirts and re-sold them instead of making them.
  • If you are a services business – Say you run a consulting firm, where you can charge customers an hourly rate for time spent working on a project. If you charge a client $50,000 for a project and it costs you $30,000 to pay your employees working on that project during that time, your gross profit on the project is $20,000.
  • If you are a B2B SaaS business – Hmmm, this is an odd one. You are selling a product, but it isn’t a physical product — it’s up in the cloud! By now, the revenue portion of the equation is pretty simply, so the real focus should be on how to calculate the cost of goods sold. In this case, you’d take a bit of a hybrid approach. I use any software or tools used to run your software, such as hosting services for example, plus the fully loaded salaries of your Customer Support or Success team. Let’s say your monthly recurring revenue is $100,000, your fully loaded salaries for a couple Support/Success employees for a given month come out to $15,000, and you pay $5,000 for hosting and other support software, you will have a strong gross profit of $80,000!

 

As you can see, the gross profit calculation for the SaaS business is a bit more ambiguous than the other two. You can’t really identify the gross profit of one individual sale or project like the physical product or services examples. Instead, the cost to produce the recurring revenue is “shared” throughout all of your customers. Furthermore, in general, your new customers/revenue should grow disproportionate to the cost of goods sold, with revenue growing faster the expense to support it!

This is one of the beauties of a SaaS business: if you’re doing it right, you will have a very good gross profit (think 70%+). This will only increase flexibility, as a strong gross profit will allow you to choose between an easier path to profitability or an easier path to fundraising.

Now you know that gross profit is not only easy to calculate, but it’s also a pretty important business health metric for you to track! That doesn’t sound so “EWW!” after all, does it?

Eww.jpg

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