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 | $24,000 | Gross Margin |
| Gross Income | $56,000 | 70.0% |
| 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 | $51,650 | Net Margin |
| Net Income | $4,350 | 5.4% |
| Initial Rate of Return | 22% | |
We can see that after cost of goods sold (the direct labor and materials cost that ...
