Dear Enterprise Iain

What on earth is gross margin? I did a search for “what is margin?” and I got this quote “Put simply, gross margin is the money left after you have covered all the variable (not fixed) costs associated with the sale of a product or service (such as wages, materials, etc.)” . I nearly passed out on the spot. I want to make money, not have to do a degree to understand what gross margin is. Is it that difficult? Is there a secret society out there dedicated to confusing entrepreneurs on the subject of understanding margin?

I looked again and found nothing on Business Gateway Zilch . So I looked up my “friendly local bank ” the Yorkshire and got this stuff I mean, what is going on? I need help.

Yours, Richard

Dear Richard,

Oh yes this is not unusual . When I was running my Enterprise Island Challenges across the UK this whole issue of understanding gross margin came up again and again. Even I may add from an MBA student.The way we talk and explain margin has been the bane of my life. So I am going to solve this problem once and for all. Do not use the word margin. Use the word contribution instead. There you go – simple.

Do not use the word margin - use the word contribution instead. Click To Tweet

I am fond of food analogies (in particular cake) so – to work out your contribution, identify all the ingredients you need and how much they cost. If the ingredients of your cake come to £1 and you then sell the cake for £3 then you have £2 left over. That £2 is NOT profit – that £2 that is your contribution. Contribution to what? Contribution to your overheads. O is for Overheads.

Contribution is the difference between the cost of making a product and what you sell it out at. You then use that contribution to cover your overheads.

So!

  1. Ingredients £1
  2. Sell Cake £3
  3. Contribution £2

Incidentally, by discussing contribution and overheads we know have two of the three three magic numbers that you must remember at all times when running your business. I will go into the third magic number shortly in another post but for now – be happy.