What is Gross Margin? A Complete Beginner’s Guide
When it comes to understanding the financial health of your business, gross margin is one of the most important metrics to know. Yet, many business owners overlook it or confuse it with other profitability measures.
In this guide, we'll explain gross margin clearly, show you how to calculate it, and explore why it matters so much.
What is Gross Margin?
Gross margin is the percentage of your revenue that exceeds the cost of goods sold (COGS). It shows how efficiently a company is producing and selling its products or services.
In simple terms, gross margin tells you how much money you keep after covering the direct costs of making or delivering your product.
Gross Margin Formula:
(Revenue - Cost of Goods Sold) ÷ Revenue × 100
Example:
- Revenue = £100,000
- COGS = £60,000
- Gross Margin = (100,000 - 60,000) ÷ 100,000 × 100 = 40%
This means you keep 40 pence of every pound you earn, before paying other expenses like salaries, rent, and marketing.
Gross Margin vs. Gross Profit: What's the Difference?
It's easy to confuse gross margin and gross profit.
- Gross profit is an absolute number (£40,000 in our example).
- Gross margin is the percentage of revenue that remains (40%).
Gross margin helps compare profitability across different companies or industries, while gross profit shows the actual amount earned.
Why Gross Margin Matters
Understanding and improving your gross margin can help your business in several ways:
- Pricing Strategy: Ensures your prices are set to cover costs and deliver profits.
- Cost Control: Highlights areas where production or service costs could be reduced.
- Business Health Indicator: Low margins could signal deeper operational issues.
- Investor Confidence: Strong margins often attract investors or lenders.
Tip: A higher gross margin means more money to invest in marketing, hiring, and growth.
How to Improve Your Gross Margin
If your gross margin is lower than you’d like, here are some practical steps:
- Review supplier costs and negotiate better deals.
- Increase prices strategically by adding more value.
- Improve production efficiency to lower costs.
- Focus on selling high-margin products or services.
What is a Good Gross Margin?
The "ideal" gross margin varies by industry:
- Retail: 20%–50%
- Software/SaaS: 70%–90%
- Manufacturing: 25%–35%
Always benchmark against similar businesses.
Coming soon: Our detailed breakdown of average gross margins by industry — stay tuned!
Common Mistakes to Avoid
- Ignoring changes in COGS.
- Over-discounting products or services.
- Focusing only on revenue growth without checking profitability.
Profitability isn’t just about selling more — it’s about earning more per sale.
Final Thoughts
Gross margin isn’t just an accounting term. It’s a powerful business performance indicator.
By keeping a close eye on your gross margin, you can:
- Make smarter pricing decisions
- Control costs more effectively
- Build a stronger, more resilient business
Want to continue building your financial knowledge?
Check out these helpful resources:
- Understanding Gross Margin — Dive deeper into the fundamentals of gross margin and why it matters.
- How to Calculate Gross Margin: Formulas, Examples and Templates — Learn step-by-step how to calculate your gross margin correctly.
- Why Gross Margin is the Health Check Your Business Can't Ignore — Discover why tracking your gross margin is critical for business success.
