What Is Gross Margin and How Do You Calculate It?
Gross margin is the share of revenue left after the direct costs of what you sold. Calculate it as revenue minus cost of goods sold, divided by revenue, and show it as a percentage. It tells you how much each sale contributes toward overheads and profit, and whether your prices cover delivery.
What is gross margin?
Gross margin measures how much of every sales dollar remains after paying the costs that exist only because you made the sale. Those are the direct costs: materials, products bought for resale, subcontractors, and labor that works directly on the job or product. Rent, office staff, marketing and software are overheads and do not go into gross margin.
Two related terms often get mixed up:
- Gross profit is the amount: revenue minus direct costs.
- Gross margin is the same figure as a percentage of revenue.
You find both on the profit and loss statement. See how to read a profit and loss statement for where gross profit sits in the layout.
What is the gross margin formula?
Gross profit = revenue minus cost of goods sold (COGS).
Gross margin = gross profit divided by revenue, multiplied by one hundred to show a percentage.
Example, with invented numbers:
Example (illustrative numbers only): a business sells goods for 10,000 in a month. The direct cost of those goods is 6,500.
| Step | Calculation | Result |
|---|---|---|
| Gross profit | 10,000 minus 6,500 | 3,500 |
| Gross margin | 3,500 divided by 10,000 | 0.35, or 35 percent |
In the example, out of each dollar sold, thirty-five cents is left after direct costs to cover overheads and profit.
How do you calculate a thirty percent gross margin?
There are two common versions of this question. Both are answered below.
Question one: what price gives me a thirty percent margin on an item? Divide your cost by one minus the margin, written as a decimal. For a thirty percent margin, that means cost divided by seven tenths.
Example (illustrative numbers only): an item costs 70 to buy or make. Price needed for a 30 percent gross margin is 70 divided by 0.7, which is 100. Check: gross profit is 100 minus 70, which is 30, and 30 divided by 100 is 30 percent.
Question two: what is my margin if I sell something at a given price? Subtract cost from price, then divide by price.
The common mistake is to add thirty percent to cost. That is a markup, not a margin, and it gives a lower margin than you intended. See the next section.
Gross margin vs markup
| Item | Gross margin | Markup |
|---|---|---|
| Based on | Selling price | Cost |
| Formula | (Price minus cost) divided by price | (Price minus cost) divided by cost |
| For the same sale | The smaller figure | The larger figure |
| Used for | Judging profitability | Setting a price from a cost |
Example (illustrative numbers only): cost 70, price 100. Margin is 30 divided by 100, or 30 percent. Markup is 30 divided by 70, or about 43 percent. Same sale, two different figures.
If you set prices by adding a percentage to cost, check what margin that produces. Setting prices by markup can leave you with a lower margin than you expected.
What counts as a direct cost?
This is where gross margin goes wrong in practice. The rule is whether the cost rises and falls with each sale.
| Usually direct (in COGS) | Usually overhead (not in COGS) |
|---|---|
| Materials and supplies used on jobs | Rent and utilities for the office |
| Products bought for resale | Owner and office salaries |
| Subcontractors on a job | Marketing and advertising |
| Direct labor on jobs or production | Software and insurance |
| Shipping in, packaging, merchant fees (depending on how you classify them) | Professional fees |
The line between the two is a judgment call. What matters is consistency. Pick a rule, apply it every month, and write it down. Otherwise your margin moves for reasons that have nothing to do with business performance. Misclassified costs are a common problem in small business books.
What is a good gross margin?
It depends heavily on the industry and the business model. A reseller, a service firm and a software business have very different structures, and any single figure quoted without a source for your sector is a guess. A more useful approach is to compare your own margin over time and by product, service or job, and to ask whether it covers your overheads with something left over.
If gross margin is falling, the usual causes are rising costs that were not passed on in prices, discounting, a shift toward lower-margin work, and mistakes in how costs are recorded.
Gross margin vs net margin
Gross margin stops after direct costs. Net margin takes off everything: overheads, interest and other items. A business can have a healthy gross margin and a poor net margin if overheads are too heavy. It can also have a modest gross margin and a decent net margin if overheads are tiny. Look at both, and see KPIs for small business for related measures.
Gross margin calculator and spreadsheet
You do not need special software. In a spreadsheet, put revenue in one cell, direct costs in another, and use a formula for the difference divided by revenue. Better still, take the figures from your accounting software so they match the books. QuickBooks and Xero both show gross profit on the profit and loss report once costs are categorized as cost of goods sold (called direct costs in Xero).
Where does margin analysis fit in the wider picture?
Gross margin by product, service or job is a useful thing for a monthly report to show, because a healthy total can hide a loss-making line. This is the kind of work covered by management reporting in a fractional controller engagement, including margin and profitability analysis. Pricing and profitability advice belongs to the fractional CFO service. Both rely on correctly coded bookkeeping. More background is in what is management reporting and how to read a balance sheet.
When is it not worth getting help?
If you sell one product or service, know your direct costs well and see them in your software each month, you can handle gross margin yourself with the formula above. Outside help starts to matter when you have many products or jobs, costs that are hard to allocate, or prices to review across the board.
English Oak's starting prices are $500 a month for bookkeeping, $1,500 for controller work and $2,500 for CFO work, custom and one fixed monthly fee. See pricing and what we do. This is general information, not tax or investment advice. English Oak does not prepare tax returns, audit or give investment advice.
New to a term used here? Our small business finance glossary defines it in plain English.
Need this done for you? See our Fractional Financial Controller service, or pricing. English Oak Financial does not prepare tax returns, perform audits or give investment advice. This guide is general information, not tax, legal or investment advice.
Related pages
Common questions
How do I calculate gross margin dollars?
Subtract your direct costs from your revenue. The result is gross profit in dollars. Divide by revenue to get the percentage.
Is gross margin the same as profit?
No. Gross margin ignores overheads. Net profit is what remains after all costs. A business can have a high gross margin and still lose money if overheads are too large.
What is the difference between gross margin and gross profit?
Gross profit is an amount of money. Gross margin is gross profit expressed as a percentage of revenue.
How do I calculate a price for a target margin?
Divide the cost by one minus the target margin written as a decimal. For a thirty percent margin, divide cost by seven tenths.
Why does my margin look different in my software and my spreadsheet?
Usually because costs are classified differently, or because some direct costs sit in overhead accounts. Agree on which costs count as direct and apply that rule in both places.
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