How to Calculate Gross Margin: Formulas, Examples and Templates
Gross margin is one of the most important indicators of your business’s financial health.
Knowing how to calculate it accurately can help you set better prices, control costs, and drive profitability.
Here’s a simple, step-by-step guide on how to do it.
What is Gross Margin?
Gross margin measures the percentage of revenue that remains after covering the direct costs of producing goods or services.
In short:
It shows how much profit you keep from each sale before paying overheads like salaries, rent, or marketing.
Gross Margin Formula
The formula for calculating gross margin is:
Where:
- Revenue = Total sales income
- Cost of Goods Sold (COGS) = Direct costs of producing goods or services
Step-by-Step Example
Let’s walk through a practical example.
Example:
- Revenue = £250,000
- COGS = £150,000
Calculation:
Result:
You have a gross margin of 40%. This means for every £1 earned, you keep 40p after covering production costs.
Why Gross Margin Calculation Matters
- Pricing Decisions: Know if your prices are high enough to cover costs and deliver a profit.
- Cost Management: Identify if rising supplier costs are eating into profits.
- Profitability Tracking: Monitor changes over time to improve financial performance.
- Investor Readiness: Lenders and investors often check gross margin before backing a business.
Tip: Regularly calculating and reviewing your gross margin is critical — especially during periods of inflation or supply chain disruption.
Common Mistakes to Avoid
- Ignoring Hidden Costs: Always accurately capture all direct production costs.
- Mixing Gross Margin and Gross Profit: Remember gross margin is a percentage, gross profit is an absolute number.
- Using Outdated Data: Base calculations on the latest figures for revenue and costs.
Frequently Asked Questions
Q: What’s the difference between gross margin and profit margin?
A: Gross margin looks only at direct costs. Profit margin (net margin) looks at all expenses including overheads.
Q: How often should I calculate gross margin?
A: Monthly is ideal for SMEs; quarterly is the minimum recommendation.
Q: What’s a good gross margin?
A: It depends on your industry. Retail averages 20–50%, while SaaS companies often have 70–90% gross margins.
Final Thoughts
Learning how to calculate gross margin is a basic but powerful skill for any business owner.
It allows you to:
- Stay competitive with pricing
- Improve operational efficiency
- Maintain long-term profitability
Coming soon: How to improve your gross margin and boost business resilience — don’t miss it!
Continue building your financial skills with these essential guides:
- Understanding Gross Margin — Learn the core concepts behind gross margin and why it's critical for your business.
- Gross Margin vs Net Margin: Why the Difference Matters — Understand the difference between gross and net margins to make smarter financial decisions.
- Why Gross Margin is the Health Check Your Business Can't Ignore — Discover why tracking your gross margin can predict your business’s overall health.
