If You Don’t Understand Margin, You Don’t Understand Business

Summary

• If you find yourself working hard all month with little to show for it in your bank account, it's likely because you don't understand the difference between gross and net margin.
• Gross margin is what's left after direct costs of fulfilling your goods or services are subtracted from revenue; net margin is what remains after all expenses are paid.
• Understanding and improving gross margin is vital as it directly influences net margin, ultimately affecting what you take home.
• You should aim for at least an 80% gross margin in service-based businesses; this is a rule of thumb for healthy profitability.
• To increase gross margin, you can either decrease the direct costs of service or increase the price of your service.
• Each incremental point increase in gross margin can significantly enhance your business's profitability, allowing more budget for customer acquisition and operational costs.
• Many successful businesses operate with extremely high gross margins, sometimes up to 99%.
• Don't let mental barriers prevent you from charging more for your services; it's essential for profitability and scalability.
• Periodically review your own service offerings to determine your gross margin and explore ways to improve it.
• Increasing your gross margin, even slightly, can result in a substantial increase in net profit by the end of the year.
• Remember, improving gross margin isn't just about charging more; it's about managing costs effectively to grow your business sustainably.

Video

How To Take Action

A good way of doing better in business is to focus on gross margin. It is the money left after you pay for what it costs to sell your service. Here's how to make your business healthier:

1. First, aim for an 80% gross margin. This is a good rule for making a profit.
2. To increase your gross margin, you can lower the cost to do your service or raise what you charge.
3. Every small change in gross margin can really help your business make more money by the end of the year.

So, here's what you specifically need to do:

• Look at what you're charging for your service. Can you raise the price without losing customers?
• Check out the cost to provide your service. Can you find a way to spend less without cutting quality?
• Remember your gross margin should be at least 80%. This lets you spend money on getting new customers and covers other costs.

Don't be scared to charge more for your services. Big companies sometimes have gross margins up to 99%. Keep your costs in check and charge the right price. This helps your business grow and make more money.

Every few months, sit down and calculate your gross margin. Always look for ways to improve it. If you have to, change your prices or find cheaper ways to give your service. This makes sure you keep making more profit and stay on track with your business goals. Remember, this isn't just about asking for more money, it's about being smart with your costs too.

Quotes by Alex Hormozi

"If you don't have an adequate grasp on the difference between gross and net margin, you're missing a key component of business health."

– Alex Hormozi

"Each incremental gross margin point is enormous."

– Alex Hormozi

"The gross margin is the one that begets, that creates the net margin."

– Alex Hormozi

"You have to get over this mental barrier that you have around what you're able to charge for things that don't cost you a lot of money."

– Alex Hormozi

"The two ways you can increase your gross margin is number one you can decrease the cost and number two you can increase the price."

– Alex Hormozi

Full Transcript

if you've ever struggled at the end of the month and worked all the way there to only to look at the bank account and find that there was nothing there there was too little for you to take out and then been like i literally just worked for an entire month for nothing then this video is for you all right so one of the number one issues that i see when i talk to small business owners of ms or medium-sized business owners is that they don't have an adequate grasp on the difference between gross and net margin and the reason i'm coloring the background green and i'm using my green pen is that margin is about the money so um this is a topic that people do not talk about it is also probably the number one thing that i look at in a business to determine its health and whether i would be interested in investing or any of those types of things so let me break down the difference between gross margin and net margin and then i'm going to tell you the functional ways that i use to fix a business alright so gross margin gross margin is what the direct cost of fulfilling your goods or services are and so the equation for it don't get everyone's like i don't like math it's subtraction all right it's not math that you be you're confused about if you like zone out at this moment it's because you don't want to do the thinking to understand the words i want to be really clear i'm literally going to use subtraction here all right it's the revenue how much money you're making minus the cost of goods sold all right that's the cogs now the thing is if you're in a service business your cost of goods sold isn't the physical products that you're selling because you're not selling those you're selling people you're selling payroll hours all right and so the cost of goods sold for a service business which is what the majority of people are listening to this are using is the incremental cost of the additional unit which means that that doesn't count your front desk roll that doesn't count your hr director it doesn't count your rent none of that stuff counts it's just the cost of one additional unit all right very important your net margin and i'm going to give you examples in a second your net margin is your chop right that's what it's the juice at the end of the month it's what you get after everything is paid what's left over that's what you end up taking home all right but the gross margin in my opinion well they're both obviously very important but the gross margin is the one that begets that creates the net margin and this is the one where i always focus and this is the thing that i fix and this is what i help people fix and this is the game all right so my revenue minus cost so let's say we're selling a service for 60 per per you know per hour that's what that's what let's just say you know you're a hair stylist or your trainer doesn't matter right you're selling 60 right in your business and your cost of goods sold let's say is 20 bucks right you're paying somebody 20 for the 60 thing you're like that sounds good there's 40 left over for me this makes sense right wrong all right and i'll get to why in a second and what number i use um but let's just do this so you can understand what the gross margin is here so the gross margin on this and that's assuming we're not using any product to like work on this if you were like a hair stylist for example but let's just say simply here 60 is what you're charging 20 is what it costs and 40 is left over right now what you do to figure out your margins you take that 40 right what's left over divided by the 60 of revenue which is what you got gross and what that does is it gets 66 percent that's the gross margin you'll be like oh that that sounds reasonable that's not that much you know that's not that bad the thing is is each incremental gross margin point is enormous and so let me show you the difference so let's say at the end of the year you're running a business that runs on 66 gross margins and let's say at the very end of the year now we're in the net margin category you uh you end up with 12 margins all right now most brick and mortar businesses run around there crazy right but that's what most brick and mortar businesses run around so if you're at 12 margins and i say listen you got to be at 80 people like well 80 and 66 it's not that different if you bumped your margins to 80 percent what happens at the end of the year that's 14 all right so what that does is you now have 26 net margins at the year we more than doubled we 2.2 x how much you make so do you think this is important can i double how much you make simply by changing this one number yes all right so let's use the 80 example which by the way is my rule of thumb this is the number that i get any service based business over all right doesn't matter what you're selling this is what you have to get over all right now i'll show you the difference between 80 90 95 100 in a second but this is important all right so if 80 uh gross margin is what i need there's two ways i can do it one i can decrease this cost right i could say that i get this to 12 12 right this becomes 12 bucks so cross that out and now my uh my new uh take home on this is 48 dollars right and so 48 dollars over 60 equals 80 so one way you can increase your margin is decreasing your cost gross margin the cost of actually doing the thing right the second way is by increasing how much you charge this guy right and so let's say instead of 60 and we have this 20 so what is how do we get 80 loafed over if we have a 20 cost well it's easy with this number because 20 is 20 right and so that means that you'd have to charge a hundred dollars for your 20 thing to have an 80 margin and so way number one you decrease the cost of fulfilling the thing way number two you increase the price right now this is why this is so important obviously i showed you at the end of the year you'd have a lot of money but besides that if you're making a hundred dollar or you're charging a hundred dollars or something right and it cost you 20 you got 80 left over all right now from that 80 and here's what's important you have to pay for everything else in the business and have enough money to market to acquire more customers and you have to have enough money uh uh to have a profit right and so it seems like you're like eighty percent alex that's crazy and so by the way all successful businesses the biggest businesses in the world they're not running 80 margins they're running 99 gross margins all right and you're like well they're only that's only 19 more it's actually not it's so much more than that so let me break down this difference real quick and then i'll finish this example so the difference between 80 margins 90 margins 95 margins right uh i'll just go all the way to 100 right and 100 let's do this is that difference between 80 and 90 is that this is twice as profitable as this why because it's half the cost right it means i took that 20 and made it 10 right that's the difference you're looking at this side of the equation not all of this all right this is between 90 and 95 gross margins again twice as profitable and what i mean by that is that you can sell twice as many people for the same cost that is the magic and that is how you scale that is how you get something that's enormously profitable allows you to acquire customers and has tons of profit kicking off every single month and so this is where a lot of entrepreneurs get messed up because they feel bad about charging a lot for their services or a lot for their products or whatever right the thing is is that if you do not do this you will make no profit and you will not be able to scale you will not help more people unless you get this price you got to get over this mental barrier that you have around what you're able to charge for things that don't cost you a lot of money right right okay so back to this example so if i have 80 left over that means that it depends on what my cost of acquisition is so let's say uh you know there's a certain percentage of my revenue that i'm willing to give for cost of acquisition let's say it's 20 right so if 20 of this i'm willing to give uh that means that 16 is what i have left to market this right because you see like you can only use it off of what's left here and you still after you pay your marketing right you still have the rest of your costs you still have rent you still have payroll you still have you know a payroll for all the non-essential stuff you still have software stuff all these other costs of doing business all right that have to come out of just the remainder between here and here all right this is the game and so in in sum total here if i'm looking at a business the big number that i'm looking at is 80 and that's what i i target i target any business especially for service that's over 80 and so if i'm trying to invest in something i'm trying like this is the game that we get to and so you can do this for any brick and mortar business for your business for anything you got to be over 80. and ideally pushing from 80 to 90 or 90 to 95 at each of these increments doubles the productivity of the business again right and that's where it gets magical and so the two ways you can do it just as a quick recap to increase your gross margin is number one you can decrease the cost and number two you can increase the price and that is how you can increase your gross margin percentage all right so i hope that was i before you hope that made sense i hope if you look at your own services and you're like well like what's my gross margin break it down what's the additional cost for one more person right um if i like i said earlier if i was selling something for 60 and if you don't know let's say you've got one person i'll give you one more example for this let's say you've got the type of business where one person fulfills for many people because you're like i don't know what my cost would be so i actually had this example not that long ago i was at a mastermind and a guy said he's got coaches and they coach people right and so i said well what are you know what are your gross margins he's like i have no idea i was like well let's walk through it together so he was paying his coach four thousand dollars a month all right that's what he was paying his coach and i said cool how many clients can your coach handle he said well um my my coach can handle uh 40 people all right 40 clients i was like okay what do you charge your clients per month he said well i sell packages and i was like all right what are your packages costing it's like they're 1200 packages i was like okay what does 1200 get me he said it gets you three months i'm going to give you a real world example here so please you dice dig this all right which means that it's 400 per month if you spread it out right so he's got 40 clients 400 a month is what is what they're what they're charging all right which means 40 times 400 hopefully my math is right here is 160 000 hopefully am i missing something up here i think it's 160 000 isn't it uh zero four times four thousand sixteen thousand i was like whoa um is sixteen thousand dollars per month right that's cool right that's neat so sixteen thousand dollars per month and the cost of the coach is four thousand right everyone following with me so it means that there's twelve thousand left over so that's what's left over after the cost and then we're just dividing it by the total revenue right which is this guy you just bring it back down so it's just 12 divided by 16 right which in this instance would be 75 so he's close to 80 but he's like well you know i don't want to change anything because because i'm already at 75 but remember at the end of the year the end of the year let's say you've you've got 15 margins right let's just say at the end of the year you got 15 percent bumping the extra five takes you to 20 right you're like oh wow that doesn't seem like a big difference 15 to 20 net margins at the end of the year is a 25 increase in how much money you make that is how important this is and so anyways so what would he need to do he either has to pay this guy less or he's got to charge charge more money here and so um the way to figure this out backwards if you wanted to if you didn't want to change excuse me if you did want to change your uh your price to get it over 80 then you simply uh basically increase what this number needs to be until it's 80 so um gosh what's the it's 1.6 times 8 whatever that is uh eight and then uh uh god it's uh 12.8 yeah so that would mean that he have to get to 12 800 if he wanted to get over 80 which means he either needs to charge the the extra uh 40 clients an extra uh 200 no 20 yeah you need to charge an extra 20 bucks here right per month or he could pay this coach 3 200 per month and that is how he would get from 75 to 80 and that my friends is the game so hope you found this useful hopefully you like this hopefully you thought this was awesome if you didn't um well please tell me i just want to make stuff that you guys find valuable this is the game this is the stuff that i dive super deep into when i'm trying to fix a business model uh or i'm consulting with somebody and i hope you find that valuable too so anyways keeping awesome please leave a post or review or any of that good stuff and i will see you on the next one bye