Bill Hanna explains why CFOs obsess over gross margin and how raising it from 50% to 60% creates more cash, protects against downturns, and increases company valuation. Three levers work: pricing, cost management through supplier changes, and selling more of your highest-margin products to customers you control.
How do CFOs increase gross margin and why do they care so much about it? In our example here, we have a company that has revenue of $1,000, COGS $500, with gross margin of 50%. CFOs look at this and you want to increase the gross margin to 60%. Why? Well, simply because if you have more cash in your business, you generate more profits from the same sales you already have. You can invest that in the business in hiring more salespeople, spending more on marketing and other initiatives in the business. The second reason is protection in downturn. If you're in a recession and you're selling to the same consumer base without attracting new sales, you can extract more, uh, profits from the same sales. And higher valuation. Uh, anyone who is looking to acquire a business would look at gross margin, the stronger, the better, and revenue growth, and combine the two factors together to assign a multiple on your business, whether a multiple revenue or multiple of EBITDA profit. Okay. So how do CFOs go about this? Well, they look at our levers. We have here levers like pricing, cost management, and mix optimization. They look at pricing and examine whether we're selling at the value that we're giving. So if we're selling something for $10, well, can we sell it for $10.50 and generate more in the top line here and increase our revenue? They look at cost management, direct material, direct labor, overhead, and freight-in. And try to optimize looking at each one unit of production and trying to reduce the cost of the packaging, the ingredients by sourcing new suppliers and figuring out how to reduce something by pennies. When you reduce something by pennies, that's how you get to a lower COGS on the aggregate. Uh, they look at mix optimization, product mix, customer mix, and channel mix. Product mix, if you have 3 products, but one of them is the highest margin, you want to focus your effort on that. With customer mix, if you're selling B2B to 3 supermarket chains and one of them allows you to sell at a higher price, that's the one you want to focus all your marketing on. With channel mix, if you sell on your own website and Amazon, you typically have more control over the pricing on your own website. So you want to enhance the experience, increase the customer tutorial, the experience overall so that people are preferring to buy on your own website rather than buying on a third-party website like Amazon. If you want to get more Finance Bytes from me, subscribe to the channel.
