The cost of labor has a strong impact on the overall profitability of a company. That's why smart executives and managers have to take their man hour and labor agreements seriously. The hourly wages they permit have an impact on their costs, which in turn affect gross margins. And investors and analysts alike care deeply about gross margins because they are one of the best indicators of a company's overall success and potential. .
Simply, gross margins are gross profits divided by revenues. That means that a business with $300,000 of gross profits from sales of $600,000 has a gross margin of 50 percent -- which is substantial. Gross profits are revenues minus the costs of goods sold (COGS) -- or the costs that go into the production and sales of a good or service.
Significance of Gross Margins
Gross margins are a reflection of what part of a company's sales are profit. When owners, investors and analysts look at a company, they care about the gross profit because it shows them how much of each dollar earned is return on investment. Of course, gross margin isn't the full story. Owners and shareholders actually receive net profit -- which is what's left after deducting overhead and indirect sales costs which include utilities, rents and executive salaries.
Man Hour Agreements
A man hour agreements determine the rate an organization pays for labor -- which is a key cost that can affect gross profits and therefore, gross margins. Labor contracts with unions usually include man hour agreements. Therefore, a unionized factory can know that for each mechanic it employs, it will pay $45 an hour. That means in a 40-hour work week, a factory employing two mechanics will accumulate $3,600 in labor costs from those two employees. If the factory produces 10,000 widgets, the company will allocate 36 cents in mechanic costs to the total COGS calculation for each widget.
When trying to maximize gross margins, companies typically try to manage their costs - which include labor. Because man hour rates ultimately impact gross profits, which in turn affect gross margins, executives have every incentive to negotiate the most favorable man hour agreements possible. Labor union and temporary labor contracts are two of the most common man hour agreements. Often, even a few cents an hour saved can have a significant impact on gross profits and therefore, gross margins.
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