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Building a Small Business That Warren Buffett Would Love by Adam Brownlee

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CHAPTER 8

With Healthy Net and Gross Margins

The key principle in seeking healthy net and gross margins, in building a business that Warren Buffett would love, is that once again, it all boils down to earnings.

Gross margin is found by dividing the gross income (revenues minus the cost of goods sold) by the total sales; both can be found on the income statement. Net margin is found by dividing the net earnings (everything left over on the income statement) by total sales dollars. The larger the number the better, and a business that has been able to deliver a healthy net margin over the years that beats both the industry average and global industry averages is a business that Warren Buffett might fall in love with.

Before You Can Have Net Margins, You Must Have Gross Margins

Let us turn once again to good old Joe and his trusty hamburger stand income statement to help illustrate the difference between gross and net margin. See Table 8.1.

Table 8.1 Joe’s Income Statement

Joe’s Hamburger Stand 
Initial Investment$20,000 
Revenues$80,000 
COGs$24,000Gross Margin
Gross Income$56,00070.0%
Expenses  
Payroll$20,000 
Payroll Taxes$2,550 
Supplies$1,500 
Maintenance$2,700 
Marketing/Advertising$1,400 
Car/Travel$300 
Accounting and Legal$500 
Rent$9,600 
Phone$900 
Utilities$1,500 
Insurance$1,200 
Interest$7,000 
Depreciation$2,500 
Total Expenses$51,650Net Margin
Net Income$4,3505.4%
Initial Rate of Return22% 

We can see that after cost of goods sold (the direct labor and materials cost that ...

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