At Book Smart Accountancy we believe that growth should be measured by more than increasing turnover. For an Irish SME, growing sales without understanding gross margin can create additional pressure on cash flow, staff and working capital. Before committing to further expansion, business owners should take a close look at what each sale is actually contributing to the business.
Turnover does not tell the whole story
Revenue is often one of the first figures business owners look at when assessing growth. Rising sales can indicate strong demand and a successful strategy.
However, turnover alone does not tell you whether growth is creating sufficient value.
A business generating €2 million in revenue with a 20% gross margin has a very different financial position from one generating the same turnover with a 50% gross margin.
Gross margin measures the difference between sales revenue and the direct costs associated with delivering those sales. It provides an indication of how much remains available to cover overheads and generate operating profit.
This makes it particularly important when considering expansion.
What is gross margin?
Gross margin is generally calculated as:
(Revenue minus Cost of Sales) ÷ Revenue × 100
The precise costs included within cost of sales depend on the nature of the business.
For a retailer, this might include the purchase cost of goods sold. For a manufacturer, it could include materials and direct production costs. For a service business, direct labour or subcontractor costs may be relevant.
The important point is to ensure that the calculation reflects the genuine cost of delivering the product or service.
If direct costs are understated, the reported gross margin can look healthier than the underlying economics of the business.
Why margin matters when you are growing
Growth often requires investment.
A business may need additional employees, larger premises, more stock, new vehicles, additional equipment or increased marketing expenditure.
These costs can increase before the additional revenue becomes fully established.
If the underlying gross margin is weak, there may not be enough contribution from additional sales to cover the increased overhead.
This can result in a situation where the business becomes larger without becoming significantly more profitable.
That is one of the reasons some SMEs can experience financial pressure despite reporting strong sales growth.
Review margin by product and service
An overall gross margin figure is useful, but it can hide important differences.
Consider a business selling five different products or services. One may generate a 60% gross margin while another produces only 15%.
If management looks only at total revenue, it may assume that the strongest-selling product is the most valuable.
That is not necessarily the case.
Reviewing gross margin by product, service, customer group or sales channel can provide a much clearer picture of where value is being created.
It may reveal that certain areas of the business consume significant time and resources without generating an adequate return.
Watch for margin erosion
Margins can decline gradually without creating an obvious warning sign.
Supplier prices may increase. Discounts may become more common. Labour costs may rise. Customers may negotiate longer contracts at lower prices. Delivery and fulfilment costs may increase.
Individually, these changes may appear manageable.
Collectively, they can have a substantial effect on profitability.
For example, a business operating on a 40% gross margin may not immediately notice a two or three percentage point decline. Across a significant level of turnover, however, that reduction can represent a considerable amount of lost gross profit.
Regular monitoring can help identify changes before they become embedded in the business.
Consider whether pricing reflects your current costs
A gross margin review should lead to questions about pricing.
When was the last time you reviewed your prices?
Are they based on current supplier and employment costs?
Are discounts being applied consistently?
Are customers receiving additional services that are not included in the original price?
Businesses sometimes maintain prices for too long because they are concerned about losing customers.
That approach can become expensive if costs continue to rise while selling prices remain unchanged.
Pricing decisions should consider the value provided to the customer, the competitive environment and the actual cost of delivering the product or service.
Do not assume more sales will solve a margin problem
This is an important point for growing SMEs.
If every additional €1 of revenue produces only a small amount of gross profit, increasing sales volume may not resolve the underlying problem.
In some cases, additional sales can actually increase pressure if they require substantial working capital or additional staffing.
Before pursuing aggressive growth, business owners should understand the contribution each additional sale is expected to make.
This is particularly important where the business is considering borrowing to fund expansion.
Use margin to guide growth decisions
Gross margin should be considered alongside other financial measures, including operating profit, cash flow, debtor days and working capital requirements.
For example, a new contract might appear attractive because it generates significant additional turnover. A closer review might reveal that the margin is lower than existing business, payment terms are considerably longer and fulfilling the contract requires additional staff.
The contract may still be worthwhile, but the decision should be based on the complete financial picture.
Build growth on a stronger foundation
Growth can create excellent opportunities for Irish SMEs, but sustainable growth requires a clear understanding of the economics behind the business.
Reviewing gross margin before expanding can help identify which products, services and customers are genuinely contributing to profitability.
It can also highlight where pricing needs to change, costs need to be controlled or resources need to be allocated differently.
At Book Smart Accountancy, we believe that the strongest growth strategies are built on financial visibility. Knowing your gross margin gives you a clearer understanding of what your sales are actually contributing and whether the business is financially ready for its next stage.
If you would like to discuss your business, contact us by email michelle@jmcqaccountants.ie or visit booksmartaccountancy.ie.
Disclaimer
This article is based on publicly available information and is intended for general guidance only. While every effort has been made to ensure accuracy at the time of publication, details may change and errors may occur. This content does not constitute financial, legal or professional advice. Readers should seek appropriate professional guidance before making decisions. Neither the publisher nor the authors accept liability for any loss arising from reliance on this material.
