Crimes against gross margin
The two most important figures on the pitch deck are revenues and gross margins. Revenue says, “Look how big I’m getting!” and gross margin follows with, “And look how strong!”
Gross margin is all about the health of the business. It is the profitability indicator. Gross margins are net revenues minus cost of goods sold or COGS
Investors didn’t used to care that much about margins in the early stages. So long as there was a path to exit, that’s all that mattered. You could pour a ton of money into a startup and outpace competitors and get to the next round of funding on a revenue-based valuation.
Not so today. Investors now are scrutinizing path to profitability more closely, and at earlier stages. That means they are really looking at your gross margins.
But sometimes startups quote an attractive gross margin to investors, then during due diligence the figure gets ugly and investors become uninterested.
Don’t be a victim to misrepresented COGS.
Here are some of the crimes against gross margins:
Missing raw material all-in costs
Your ingredients and packaging costs should include inbound freight and any storage fees. Projections on raws can only correctly be determined by talking with your suppliers about volume price tiers and contracted pricing vs spot. You should have high and low assumptions that cover anticipated market volatility for some inputs.
Forgetting about shrink
Shrink is loss of inputs during production (think moisture loss, line purging, what’s left in the tank, the labeler goes crazy, that sort of thing). So there is no doubt you’ve accounted for shrink, make this a separate item on the P&L and don’t lump it into raws.
Not including direct labor
If you self-manufacture, even if you yourself are working the production line “for free”, you must account for what would be the labor cost (with burden) when eventually someone else takes your spot. This includes set up, change overs, clean up, and sanitation.
Missing factory overhead
This is the manufacturing overhead or indirect costs associated with production, like electricity.
If you are contract manufacturing, the cost of raws and shrink should be transparent to you. Therefore, the toll charge is simply the co-man’s labor, overhead, and profit.
Sometimes the worst crimes are the ones you commit against yourself
A common mistake is subtracting COGS from gross revenues (gross sales) to get to gross margin. Miscalculating gross margin off of gross instead of net revenues will make for an inaccurately lower gross margin than your true figure.
Example:
Other terrors
Under-accounting reductions to revenue can be just as frightening.
It’s a crime for sure when customers take early payment discounts and in fact do not pay early. It’s especially criminal when they are the ones imposing the terms. Get used to it.
Spoils allowance is another reduction to revenue that some distributors and wholesalers take automatically regardless of actual damaged or spoiled product.
I don’t want to diminish the importance of offering discounts – but this is where most brands get bullied and lose control. The sad story of trade spend that was either unauthorized or not executed at shelf is all too common. Oversized trade spend will count against you if you are not consistently on top of disputing bogus charge backs.
Put your best foot forward when pitching to investors. The sooner you get past the validity of your margins, the more time you will have to sell them on the market opportunity and your right to win.
All my best,
Jennifer
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