Last week a business owner bought me drinks to celebrate his "best quarter ever." $750K in revenue.
I asked one question: "What's your gross margin?"
Blank stare. Calculator fumbling. Then: 32%.
After paying subs, materials, and direct labor, this guy had $240K to cover rent, insurance, the back office, his salary, and literally everything else. His record quarter left him making less than a low-level corporate drone.
I guess I’ll buy the drinks.
Revenue is Vanity. Gross Margin is Sanity.
Most owners get drunk on top-line numbers. But if you aren’t charging enough or paying too much for labor, revenue is a bad metric.
Your real business = Revenue minus direct materials/costs minus direct labor.1
That's your gross profit. That’s the dollar amount.
Gross margin is the percentage (gross profit/revenue). Everything else is accounting theater.
After looking at hundreds of P&Ls, the pattern is clear:
30% gross margin: You bought yourself a crappy job with extra paperwork2
40% gross margin: You're treading water, your probably making some money but can’t really invest for the future
50% gross margin: This is the sweet spot where you can pull in some serious cash and invest for growth
60% gross margin: Now we are cooking with gas. This is where I see really good companies get to
70%+ gross margin: Call me. I want in on whatever you're doing
The Key Questions
Three questions that separate real businesses from expensive hobbies:
Can you calculate your gross margin without texting your bookkeeper?
When you make big decisions, do you look at gross margin or just stare at revenue like a teenager on TikTok?
If you're below 40%, what specifically are you doing about it? (And "hoping things get better" isn't a plan)
That guy from the bar? We found $180K in pass-through work he could either eliminate or mark up properly. Six months later, 48% gross margin. Same business, same team, actual profit.
Stop celebrating revenue. Start obsessing over gross margin.
Your bank account will thank you.
Alan
P.S. That owner who went from 32% to 48% margins? Started with a free 30-minute call where we x-rayed his P&L. If you want to stop subsidizing your subs' businesses with your sweat, grab a slot.
1 Direct is anything that goes away if that customer goes away. Anne in accounting stays even if Customer X cancels but Peter who was delivering services to Customer X needs a new customer or he’s out of here.
2 There’s an exception to this rule. If you are truly just passing through labor or materials that you don’t manage or handle at all, you can remove that from the calculation. Start with revenue after true passthrough costs instead of revenue.