There are a bunch of financial metrics you can track like EBITDA, Revenue, COGS, W2 Multiplier, and Net Profit. The one metric to rule them all is Gross Margin. Is that overstated? Sure, maybe a little bit but on todays ramble I’m going to tell you why I think Gross Margin is the most important financial metric to track.
Those other metrics I talked about are important, but if you can deliver solid Gross Margin to the rest of the business you should be in great shape. The short version is Good Gross Margin = Good EBITDA.
What is Gross Margin?
Let me take just a moment to define Gross Margin and Gross Profit. Gross profit is revenue minus Cost of Goods Sold (COGS). Usually represented in dollars. It’s important to understand that your technical employees are part of COGS. They’re central to providing the services you sell to your clients as a Managed Service Provider (MSP).
Gross Profit = Revenue – COGS
Gross Margin = Gross Profit / Revenue * 100
Gross Margin is the relationship of Gross Profit dollars to revenue dollars. In other words, Gross Margin is simply Gross Profit divided by Revenue multiplied by 100 to make it a percentage.
Managing Gross Margin
As I was saying, good Gross Margin equals good EBITDA and Net Profit, or at least it should. When Gross Margin is good and EBITDA isn’t great; it’s either deliberate OR you’re mismanaging the below the line expenses. Let me say that again: if Gross Margin is good and EBITDA is bad it’s either deliberate or the business is mismanaged.
Show me a company with consistently good Gross Margin, and I’ll show you a company with consistently good bottom line profits. The key here is delivering CONSISTENTLY good Gross Margins. It’s not all that hard to deliver one quarter of Gross Margin, but doing it quarter over quarter is much harder.
What can you do to improve Gross Margin? The easiest way is to drive revenue up while keeping COGS or Cost of Goods in check. You get a compounding effect if you are able to move revenue up at the same time as moving COGS down.
Thanks for coming on this ramble with me and I hope to see you on the next one.