What is a good gross profit margin for your eCommerce business?
“What numbers do you look at in your business?”
It’s the first question we ask when we meet with ecommerce founders and business owners for the first time. If your answer is the sales dashboard on Shopify, then you’re not alone. But there are better tools you can reference.
Don’t get us wrong – Shopify is a brilliant platform with excellent front-end metrics. But it has its limitations. When it comes to understanding the financial performance and health of your business, it’s not the best form of intelligence.
Why? Revenue is a vanity metric that doesn’t show if you’re actually turning profits. Let’s look at what numbers you should be tracking instead.
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In this article:
What matters more than revenue
The biggest problem with just looking at your sales is that it doesn’t tell you if your business is actually making any profits.
What matters more than sales is your gross profit. And gross profit is more important than the statistics around sales as this number shows the quality of your sales.
Gross profit is the most important metric in your business because it is a true measure of the profit your business generates to cover your fixed expenses, like wages and rent.
Calculating your gross profit
So, how do we find your gross profit? With a simple calculation.
To calculate your Gross Profit, you need to consider all of the direct expenses associated with selling your product.
These direct expenses will include:
- The cost of your product
- The inbound shipping costs or freight costs
- Merchant and selling fees (Amazon, Stripe, Paypal and Afterpay fees)
- Fulfilment costs (postage and pick-and-pack charges)
Your business will likely have expenses that are variable in nature – for example, costs that may increase as your sales volume increases. As a rule of thumb, these variable expenses are considered direct costs.
This is important to understand so that we can accurately determine your gross profit margin.
What is a healthy gross profit margin?
Your gross profit margin will vary depending on what you sell.
- If you sell commoditized goods or are a reseller of other brands, your gross profit margins could be as low as 25 per cent.
- If you sell your own products (a classic direct-to-consumer), you should be achieving margins of at least 40 per cent and even upwards of 60 per cent.
The higher the gross profit margin, the better. The best businesses in the world have strong gross profit margins.
So what’s a healthy gross profit? It depends on your business.
If you run a fast moving consumer goods (FMCG) business that turns over less than $10 million in sales every year and your goal is to build a profitable business, we recommend you target gross profit margins of 40 per cent and above.
If your margins are lower than that, you need to be selling a lot of product to generate the net profit and cash flow.
We’ll use an example to illustrate why gross profit margins are one of the most important metrics to understand your business’ financial health.
Let’s say our fictitious ecommerce business incurs $800,000 in annual fixed expenses. The graph below shows how much in sales the business needs just to break-even on these costs at varying gross profit margins.
At a 60 per cent gross profit margin, the business only needs to turn over $1.3 million in sales annually to break-even on $800k of fixed costs.
At the other extreme, if the gross profit is only 20 per cent, the business needs to generate $4 million in sales just to achieve the same result. That is a whole lot more effort for the same financial result.
As a business founder and manager, your goal should be to explore ways to maximise your gross profit margins. Once you can see the numbers, you can start dreaming up innovative ways to improve your bottom line.
So next time you’re analysing your financial reports, put the emphasis on gross profit, not sales. It’s a far better indicator as to how well your business is really doing.
