Knowing the standards in your industry is one of the fundamentals that will keep you competitive. It will help you identify areas of weaknesses, see your strengths and notice any opportunities the company may have. So what are some of the standards you need to keep up with regarding your industry, and where do you need to focus your energy to remain competitive is a good question. There are many places to focus on, and each one will provide you with some insight and give you something to measure against. Having something to measure against gives you a standard to compare your company to, and two great ones are gross and net profits. These industry standards tell you if you are doing ok and meeting the norm for that industry. This is important for small businesses because they need to know that they are making the money they are supposed to make and are competitive within their industry.
The gross profits or gross margin is the remaining money from the total sales revenue after subtracting the costs of goods sold (COGS). The COGS are just that, the cost of what it takes to make your products or provide your service. The COGS typically includes the materials and labor it takes to make the final product. The word gross tells us that no other expenses have been taken from the total revenue at this time and lets you know what is left over to pay additional costs. The gross profit does not directly tell you your overall profit, but is a significant number to examine and compare to industry standards. We suggest that you segment out your COGS to get a better set of numbers to analyze and look at it as percentages of total revenue. Comparing this to industry standards is very important. It can tell you if you are competitively priced, paying too much for the raw material, your levels of waste from the raw material and labor, and how efficient you are in making your product. When looking at a profit and loss statement, it can tell you if you are sitting on too much inventory and have a poor turnover or bad purchasing patterns. This is because a P&L does not account for inventory on hand. Having high inventory means having money on the shelf, lowering your cash flow, and limiting other opportunities where that money can be doing something else or making you more money. The gross margin's nature allows an owner to see how well they are doing operationally compared to an industry standard and where they need to focus efforts in the operations to be better and more profitable.
The net profits are the bottom line or the company's money when all expenses have subtracted from the total revenue. This needs to include the owner's pay if you are a sole proprietor. When it comes to industry standards, the problem is that not all data takes the owner's salary into account and gives some skewed results, but it still provides us with a percentage to compare to and make decisions. Here at AGDA, we typically advise that net profits be as low as possible after knowing a company is meeting the industry standards, because that means that the company is spending money on itself to better the company. That is why it is key to be competitive with industry standards. It tells you that the company is making the correct money and can do other things. Your net profits are what is leftover. That money is what can be used to expand your company or reinvested back into the company to make the company, product, experience, or presence better. It can also be used to beef up cash on hand for additional opportunities. If this number is below the industry standards and all other areas are in line, it tells us that sales levels are typically not sufficient, and focus needs to be on increasing sales or why the sales are not enough. It can also tell us that costs between gross and net profits are too high or not in line with current norms. Every situation is different, but you want to be able to compare to the industry standard to see if you have a sustainable business and if line items are appropriate.
We have to remember that meeting industry standards are measurables that let you know where you stand compared to others in your industry. Operating within the industry norm tells you your performance against the norm, but these numbers can change with innovation and markets. If you can find innovation, you can increase your gross profits. For example, when Ford introduced the assembly line, an innovation was found and increased production time and lowered labor costs, giving a better gross profit, allowing the company to have more opportunities with the remaining cash. On the other hand, when the cost of a product goes up but a market does not allow for the sale price to match or revenue decrease due to an economic situation, and a business does not adapt to meet the industry standard, both the gross profits and net profits decrease. Overall if you know your industry standards and can meet them, you can then make decisions faster to stay ahead of what may happen. You can also find ways to make your company more profitable, whether through reinvestment or increased cash on hand to be used and distributed as the company deems appropriate. Most importantly, you know that you are making the money you are supposed to be making.