Your behavior appears to be a little unusual. Please verify that you are not a bot.

Why gross margins matter

October 22, 2014 -  By
Photo: ©

Photo: ©

In retail, gross margin is an easily calculated number. It’s the difference between how much you purchase a product for and how much you sell the product for, stated as a percentage. Example: You sell a widget you purchased for $60 for $100. Your gross profit is $40 ($100-$60), and your gross margin is 40 percent.

This number is important because the total gross profit on all products sold initially is used to pay off overhead or fixed costs. Once overhead is paid off, also known as the break-even point, companies begin to make profit at the rate of gross margin multiplied by the sale price of all items sold exceeding the break-even point. The gross profit contributes to paying off overhead. Once paid off, the gross profit contributes to net profit of the company, which is the reason many accountants refer to gross margin as contribution margin. This break-even analysis concept is one of the elementary cost-control and pricing strategies taught at business schools.

As companies increase or decrease selling prices while holding product cost constant, their gross margin rises or falls; therefore, the break-even point in terms of number of units to be sold decreases or increases based on selling price.

Here are a few examples. Assume it costs $10,000 a month to run an office, which includes rent, salaries, utilities, office supplies, etc., which are known as fixed costs.

1. Assume the selling price is $100 and costs are $60, so the company makes $40 per widget gross profit. It would need to sell 250 widgets a month to break even at $10,000. Once it sells 250 units, it begins making net profit at a rate of $40 per widget.

2. If it raises the selling price to $160 per widget, it makes $100 per widget gross profit ($160-$60). It only needs to sell 100 widgets a month to break even at $10,000. Once it sells 100 widgets, it starts making net profit at a rate of $100 per widget.

3. If the company lowers the selling price to $85 per widget, it makes $25 per widget gross profit ($85-$60). It would need to sell 400 widgets a month to break even $10,000. Once it sells 400 units, it starts making net profit at a rate of $25 per widget.

You might be thinking because you’re in the lawn care business you don’t resell a product you purchase. Instead, you provide a service. So how do you calculate gross margin and the break-even point? The key to employing gross margin as a key performance indicator in a service business is to define a unit of measure you sell because you don’t sell products. In the fertilization and pesticide application industry, many companies try to use square foot as a measure. The problem with square foot is the price per square foot isn’t the same across all jobs, which means there’s usually a minimum charge whether you’re treating 500 square feet or 1,000 square feet. Once the minimum is reached, you add a certain amount for each additional square foot. Another option is to use a job as a unit, but the problem with a job as a unit is it can be small or large. Not all jobs are equal.

I recommend defining a unit as an hour of service. By doing so, understand how many square feet can be covered in an hour. Each company needs to determine this metric based on the equipment it uses and other factors. Once you determine how much fertilizer can be spread in an hour (a unit is one hour of fertilization service), you can determine the direct cost, which is the cost to provide one hour of service before applying any fixed costs. In the lawn care industry, companies usually look for material cost of about 15 percent and technician labor to be 15 to 20 percent. Other direct costs—such as vehicle costs, workers compensation and uniforms—are usually 15 percent to 20 percent. Adding these direct costs, the most efficient companies have direct costs between 45 percent and 50 percent, making their gross margins 50 percent to 55 percent. By knowing the actual costs of these items per hour, the gross margin analysis allows companies to back into their selling price per hour while targeting the gross margin percentage of the most efficient companies.

By looking at a business using a break-even analysis and its components selling price, direct costs, gross margins, fixed costs and net profit, companies can determine if they’re making adequate profit. If not, is the problem one of pricing, cost to perform the service or cost to run the office?

Gordon, a CPA in New Jersey, owns an accounting firm that caters to lawn care and landscape companies throughout the U.S. Reach him at

This article is tagged with , and posted in 1014, Business Planner 2015

About the Author:

Gordon is a New Jersey-based CPA and owner of Turfbooks, an accounting firm that caters to land care professionals throughout the U.S. Reach him at

Comments are currently closed.