The Chicks' 12 Steps to Picking a Stock

STEP 6  Gross Margins

Note: This article focuses on Step 6 of the Chicks' Dozen. For articles focusing on other Steps, see the links listed at the bottom of the page.

This is it. You have arrived. It’s the time and place for a calculator. The other five steps -- Buying What You Know, K.I.S.S., Industry, Leader In It’s Field, and Repeat Profitability -- were a breeze, but now some "numbers" have arrived to our Chicks’ Dozen Party. Some gross numbers. Relax, parties were meant to be fun, even calculator parties. (I’m stretching it a bit here, but picture yourself sipping a cocktail in your little black dress from Tiffany’s tapping away on your calculator.) Today we are going to learn what Gross Margins are, what figures we use to calculate them, and why they are an important part of the Chicks Dozen. I’ll do my best to turn something gross into something pleasant.

Pretend the Chicks were to start our own Creative Chicks Scrapbooking Company. We have put together 100 Scrapbooks for some very excited clients. For those of you who don’t know, Scrapbooks are the "Monet" of the photo albums. Every page is hand decorated for your special pictures. You can do one for newborn babies, for family reunions, for vacations, for graduations, etc. If you still don’t get the Creative Scrapbook idea, contact Chick Susie or Chick Cheryl, on our Message Boards. They scrapbook in their sleep.

Lets say that all of the supplies to make one scrapbook totals $30. This would include the undecorated scrapbook, the stickers, the markers, and the other utensils needed to make the book. One scrapbook costs us $30 in time and material.

Now let's say the retail price for these Creative Chicks Scrapbooks is $65. They are such a hit amongst the creatively dead that these people will pay anything for someone to make them one. (Chick Susie has especially created two books for my own artistically-handicapped self.) Chicks around the country can’t get enough of the scrapbooks.

To figure the gross margins of Creative Chicks Scrapbooks, here's what we do... Calculators front and center please. (Feel free to take a sip of the beverage at this point.)

What are the total sales of the scrapbooks?
We have sold 100 scrapbooks at a price of $65.
100 x $65 = 6,500

What was our Total Cost of Goods Sold?
Each scrapbook cost us $30 in time and materials.
100 x $30 = 3,000

To get the Gross Margins, here is the calculation:
(Sales – Cost of Goods Sold) / Sales

Let’s do it, Chicky!!!

(6,500 – 3,000) / 6,500 = .5384

Here is how that was done in more detail, since I know it’s been awhile since you’ve been mathematically challenged. (Okay, maybe it’s me that it’s been awhile for.)

(6,500 – 3,000) = 3,500
3,500 / 6,500 = .5384

To get our Gross Margin to a percentage, which is how we like to express it for our Chicks Dozen, we must multiply it by 100.

.5384 x 100 = 53.84%

Rounded up, and you have 54% (Always round up when the next decimal point is over 5, leave it if it’s under 5.)

So that’s it... The Creative Chicks Scrapbooks have Pleasantly Gross Margins of 54%.

To put Gross Margins and our over 50% requirement into simpler terms: we want the sales from merchandise to equal more than twice what it costs to make it. Our companies have either figured out how to make it cheaply, or cost efficiently, or there is a huge demand for their product and they are able to charge double what it costs to make it. The more they can make on their product, the more cash they will be piling up in the bank. This is a good thing -- cash in bank.

Okay, enough of the numbers... until the next lesson. In the next lesson, we’ll see how Service Industries calculate their Gross Margins. Go enjoy the rest of the party. Pretend the calculator thing was a bad dream. (Who would ever have a black tie party anyway and tell you to bring a calculator? I can’t believe you went with me on that.)

For more on how to find the Numbers on an Income Statement, check out Getting to Know the Financial Statements.