Reading your gross margin in Xero, and what a slipping margin signals
There is one number in your accounts that quietly tells you whether the work you are doing is actually worth it. Not your revenue, and not your bank balance. Your gross margin.
The good news is that it is already sitting in Xero, and you can find it in about two clicks. The better news is that once you know where to look, a small monthly glance can catch a problem while it is still small.
What gross margin actually is
Gross profit is what is left of your income after the direct costs of doing the work. Materials, subcontractors, the things that rise and fall with how busy you are. It is your income minus those direct costs.
Gross margin is that same figure written as a percentage of your income. If you bring in $10,000 and your direct costs are $6,000, your gross profit is $4,000 and your gross margin is 40%.
That percentage matters more than the dollar figure, because it tells you how much of every sale you keep to cover your overheads and pay yourself. Two businesses can have the same revenue and completely different margins, and the one with the healthier margin is the stronger business.
How to find it in Xero
Xero works this out for you, as long as your accounts are set up so that direct costs sit in the Direct Costs section of your chart of accounts, separate from your overheads.
The quickest read is the Profit and Loss. Go to Reporting, then Profit and Loss. Xero shows your income, your direct costs, and your gross profit as a subtotal partway down, before your overheads. Run it for the last month or quarter and you have your gross profit in front of you.
To see the margin as a percentage and how it is moving, open Reporting, then Executive Summary. This report lays out gross profit and gross profit margin, and puts the current period next to earlier ones with the percentage change alongside. That comparison is the part worth your attention, because a single month tells you where you are, but the trend tells you where you are heading.
If you want the picture at a glance rather than a full report, the Business Snapshot under Reporting gives you profitability in a simple visual without running anything.
What a slipping margin is telling you
A margin that drifts down month after month is one of the earliest warnings a business gives you, and it usually means one of a few things.
Your costs have crept up and your prices have not kept pace. This is the most common cause, and the quietest, because no single invoice looks alarming. Suppliers nudge their prices, wages rise, and unless you have moved your own prices to match, the gap comes straight out of your margin.
You have been discounting more than you realised. A few deals to win work are fine, but a habit of shaving the price adds up across a year.
Your job mix has changed. If the lower margin work has grown as a share of what you do, your overall margin falls even when nothing about any single job has changed.
Or something is miscoded. Sometimes a slipping margin is really a bookkeeping issue, with a cost landing in the wrong place. That is worth ruling out first, and it is exactly the sort of thing we keep an eye on for clients.
What to do when you see it move
The first move is not to panic, it is to look. Once you can see the margin slipping, you can act while it is a small correction rather than a year-end shock.
Often the answer is on the pricing side. If your costs have risen and your prices have not, a considered price review is usually overdue. We wrote about why a small price rise does more for your profit than chasing extra sales in the maths of a price rise, and about protecting your margin more broadly in our pricing guide.
Checking your gross margin need not be a big monthly job. Two clicks in Xero, a look at the trend, and you will know far more about the health of your business than your bank balance will ever tell you.
If you would like a hand setting your accounts up so the margin reads cleanly, or working out what a slipping one is telling you, that is exactly what we do.