The Gross Profit Margin ratio is a very important profitabilty ratio used widely in all industries and businesses and it is very important to a small business owner like Jack Gordon because it gives him a very clear idea of what kind of cushion a small business has after it has paid for its cost of goods sold. This cushion is what determines the profitablity of a business and the next item that is subtracted from the Gross Profit to get to the operating income is of course the operating expenses. Thus having a good Gross Profit Margin ratio is critical to all small businesses like A Touch of Tuscany.

The Gross Profit Margin ratio is a very important profitability ratio used widely in all industries and businesses and it is very important to a small business owners like Andy and Jose because it gives them a very clear idea of what kind of cushion a small business has after it has paid for its cost of goods sold. This cushion is what determines the profitability of a company and the next item that is subtracted from the Gross Profit to get to the operating income is of course the operating expenses. Thus having a good Gross Profit Margin ratio is critical to all small businesses.

Since Lights On Electrical is a service business that does not have any cost of goods sold, the gross profit number is the same as the sales number for the firm. Thus in this case the gross margin is 100% for all the three years of 2015, 2016 and 2017 given that there is no cost of goods sold. It is important to understand however that if the firm were to partner with another contractor on a particular job, and had to pay out a certain percentage of the income to the other sub-contractor, they would see a cost of goods sold. For example if Lights On Electrical were to work on a large contract close five complex home sales that were referred to them by ABC Home Solutions and the total sales from these transactions resulted in an income of $100,000 with the proceeds being split evenly between both firms. the cost of goods sold for Real Estate Funding Solutions would be $50,000 since it would be paying that amount to ABC Home Solutions.

If Andy & Jose were to work on a large commercial building electrical wiring contract and choose to sub-contract 30% of the work to another local contractor, of the total revenues received from the job of say $50,000, they would have to pay out 30% of those top line revenues to the sub-contractor for having done the agreed upon 30% of the work. Thus this 30% would now represent their cost of goods sold on the total job revenues of $50,000 and would amount to $15,000. In the real world there would be adjustments made to this payout to account for the costs like parts, insurance etc. So while the sales for this job were $50,000, the gross profit margin would be 70%.

Quick Links:

1. Go to the Corresponding Template section for this industry.
2. Go to the Corresponding Questionnaire section for this industry.