Running a business means paying close attention to the numbers. While revenue shows how much money comes in, it doesn’t tell the whole story. You also want to stay on top of how much stays after you cover the costs of producing your goods or services. Gross margin fills that knowledge gap by showing what percentage of each sale remains once direct costs are paid.

Gross margin helps you measure profitability using a simple percentage that’s easy to compare across products, time periods, or even industries. Once you calculate yours, you can see which areas of your business are the most profitable, where costs are eating into sales, and how your performance stacks up against competitors. In this guide, we’ll go over what gross margin is, how to calculate it, and how to use it to make better financial decisions.

Free Gross & Net Margin Calculator

Use our free Gross & Net Margin Calculator to quickly see how profitable your business really is. Just enter your revenue, costs, and expenses, and the tool will instantly show your gross and net margins. It’s a simple way to understand your bottom line and make smarter financial decisions with no spreadsheets required.

Gross Margin & Net Margin Calculator

What Is Gross Margin?

Gross margin is the percentage of revenue you keep after paying the direct costs of producing or delivering your product or service. These direct costs, called cost of goods sold (COGS), includes raw materials, packaging, direct labor, and shipping related to production. It does not include rent, utilities, marketing, or administrative costs since those are operating expenses, not direct production costs. By subtracting COGS from your revenue and then expressing the result as a percentage, you see how much profit you earn on each dollar of sales.

It’s easy to confuse gross margin with gross profit, but they’re different. Gross profit is the dollar amount you earn after subtracting COGS from revenue. Gross margin takes that figure and divides it by revenue to create a percentage. For example, if your business earns $100,000 in sales and your COGS is $60,000, your gross profit is $40,000. When you divide that by $100,000, your gross margin is 40%. That percentage tells you that for every dollar of sales, you keep forty cents after paying direct costs.

Why Gross Margin Matters is So Important For Your Business

Gross margin helps you measure profitability in a way that raw revenue can’t. High sales numbers may look impressive, but if costs are eating up most of that revenue, you’re left with little room to grow. By looking at gross margin, you can see how much profit your sales are actually generating.

Case in point: Investors and lenders use gross margin as a quick way to judge how well your business manages production costs. A strong margin suggests you’re running your operations at maximum efficiency and leaving room for reinvestment, while a weak margin signals trouble. Knowing this percentage also helps you decide when to adjust prices or improve purchasing strategies.

Gross margin is also valuable for long-term planning. You can use it to decide which products to promote, how to expand into new markets, or where to reduce expenses. Comparing your margin to industry averages can show you if you’re on track or if adjustments are needed to stay competitive.

What is the Formula for Gross Margin?

The formula for gross margin is simple, but breaking it down helps you see exactly how it works. You start with total revenue, subtract cost of goods sold (COGS), divide the result by total revenue, and then multiply by 100 to express it as a percentage.

Gross Margin = Revenue Divided by (Revenue–COGS)​ × 100

This formula shows how much of your revenue turns into profit after you cover production costs. Expressing profitability as a percentage makes it easier to track performance over time and compare results with businesses of different sizes.

Step-by-Step Example of Gross Margin Calculation

Let’s work through a practical example to see how gross margin is calculated in real terms. Imagine you run a small bakery. In one month, your bakery earns $50,000 in revenue from selling bread, cakes, and pastries. During that same month, your COGS (ingredients like flour, sugar, eggs, packaging, and direct labor) adds up to $30,000.

Step one is subtracting COGS from revenue. That gives you $20,000 in gross profit ($50,000 – $30,000). Step two is dividing that gross profit by total revenue. In this case, $20,000 ÷ $50,000 = 0.40. Step three is multiplying by 100 to turn it into a percentage. Your gross margin is 40%.

This percentage tells you that for every dollar in sales, you keep forty cents after paying for direct costs. You can use that information to decide if your pricing works, if you need to renegotiate supplier contracts, or if some products cost too much to make compared to what they bring in.

To show how margins vary across businesses, consider a manufacturer. Suppose the manufacturer earns $200,000 in revenue and has $120,000 in COGS. The gross profit is $80,000, and dividing that by $200,000 gives a gross margin of 40%, the same as the bakery. While the dollar amounts differ, the percentage gives a fair way to compare how profitable each business may be.

Common Mistakes in Calculating Gross Margin

When you calculate gross margin, small errors can throw off your results. Many business owners either confuse terms, leave out costs, or compare numbers without proper context. Here are the most common mistakes to watch for:

  • Mixing Up Gross Margin and Gross Profit: Gross profit is the dollar amount you keep after subtracting COGS from revenue. Gross margin expresses that result as a percentage. If you treat them as the same, your analysis won’t be accurate.
  • Leaving Out Direct Costs in COGS: COGS includes raw materials, packaging, direct labor, and shipping tied to production. If you leave out any of these, your margin looks stronger than it really is, which can lead to poor pricing decisions.
  • Using Mismatched Time Periods: You need to calculate both revenue and COGS for the same time frame. If you compare quarterly revenue against one month of costs, your margin doesn’t reflect reality.
  • Comparing Industries Without Context: A margin that’s strong in one industry may be weak in another. For example, a 40% margin might be excellent in retail but below average for software. Always measure against businesses in your field.

How to Improve Your Gross Margin

If your gross margin isn’t where you want it to be, there are ways to raise it without cutting corners. You can look at both sides of the formula: reducing costs that make up COGS or adjusting the way you set prices. Here are some of the most practical strategies:

  • Negotiate Better Supplier Contracts: Review your supplier agreements regularly. Even small discounts on raw materials or shipping rates can increase your margin. Building stronger relationships with suppliers can also give you leverage for better terms.
  • Reduce Waste in Production: Track where materials, labor, or time get wasted during production. By tightening those areas, you cut costs without reducing quality. Even modest improvements add up over time.
  • Adjust Pricing Strategies: A small price increase, if done carefully, can improve your margin without scaring away customers. You can also test premium pricing for products that offer higher value or exclusivity.
  • Streamline Labor Costs: Make sure labor hours are used efficiently. Cross-training employees or improving scheduling helps reduce unnecessary expenses while keeping output steady.
  • Prioritize High-Margin Products or Services: Look at your sales mix and identify items that generate the best margins. Promoting or expanding those offerings can lift your overall margin, even if other products remain unchanged.

Industry Benchmarks for Gross Margin

Gross margin targets vary widely across industries, so it helps to compare your numbers against others in your field. These benchmarks give you a sense of what’s typical and where you may need to adjust. Keep in mind that averages can shift based on company size, business model, and region.

  • Retail: 25–35%: Retail businesses usually deal with high competition and tight pricing. Margins are lower compared to other industries because of the costs tied to inventory and promotions.
  • Manufacturing: 35–50%: Manufacturers often see stronger margins due to control over production costs and the ability to scale. Still, margins can swing depending on raw material prices and labor efficiency.
  • Software and SaaS: 70–90%: Software companies typically report very high margins since direct production costs are low. Most expenses are tied to development and support rather than each additional sale.
  • Food and Beverage: 20–30%: Restaurants and food producers tend to operate on thinner margins due to ingredient costs, spoilage, and labor. Careful cost management is vital in this sector.

Gross Margin vs. Other Profitability Metrics

Gross margin is only one way to measure profitability, and it doesn’t capture the full picture on its own. To really understand how your business is performing, you should compare it with other common metrics. Each one highlights a different stage of your financial results.

  • Operating Margin: This metric includes operating expenses such as rent, salaries, and marketing. It shows how much profit you keep after covering both direct production costs and operating costs.
  • Net Profit Margin: Net margin goes further by factoring in interest, taxes, and all other expenses. It reflects your final profit as a percentage of revenue and shows what you actually take home.
  • Contribution Margin: Contribution margin looks at sales minus variable costs and shows how much is left to cover fixed costs and contribute to profit. It’s often used for product-level analysis.

By comparing these metrics side by side, you can see how each layer of cost affects profitability and where you may need to make adjustments.

Using Gross Margin to Guide Business Decisions

Once you calculate gross margin, the real value comes from putting the numbers to work. You can use the percentage to shape pricing strategies, choose which products to promote, and plan for growth. Here are some ways to apply gross margin in your business:

  • Set Smarter Prices: Use gross margin to decide if your prices are high enough to cover costs and still produce profit. If your margin is too thin, a small increase may make your business more sustainable.
  • Identify Profitable Products or Services: Compare margins across your product or service lines. High-margin items are worth promoting and expanding, while low-margin items may need adjustment or removal.
  • Plan for Growth and Expansion: Reviewing gross margin helps you see if there’s room to expand into new markets or introduce new products. A strong margin gives you flexibility to reinvest in growth.
  • Evaluate Supplier and Production Costs: By watching how gross margin changes over time, you can spot rising costs and address them early. This might involve renegotiating with suppliers or improving production efficiency.
  • Improve Forecasting and Budgeting: Gross margin gives you a reliable baseline for financial planning. When you forecast revenue, you can use your average margin to estimate how much profit will remain.

Tools and Software to Help You Calculate Gross Margin

A few simple tools can save you time and reduce errors while giving you quick insights into your numbers. From basic spreadsheets to full accounting platforms, here are some of the most practical options:

  • Spreadsheets (Excel or Google Sheets): You can set up formulas to calculate gross margin quickly using your revenue and COGS. Spreadsheets are flexible, making them a good choice if you want to customize reports or run quick scenarios.
  • Accounting Software (QuickBooks, Xero, FreshBooks): Most accounting platforms automatically track revenue and COGS, then generate gross margin reports for you. These tools also let you view performance over time and spot trends more easily.
  • Business Intelligence Tools: Platforms like Tableau or Power BI can integrate with accounting software and provide visual dashboards. These options make it easier to share margin results with your team and track changes over time.
  • Professional Tax and Accounting Services: Working with a professional service, such as USA Tax Gurus, helps you interpret gross margin in the context of your overall financial health. Beyond just calculation, you get guidance on pricing strategies, tax planning, and business growth.

Need Help Improving Profitability For Your Business?

Gross margin is a way to measure how much of your sales remain as profit after production costs. By tracking it regularly, you can see which products or services perform best, how pricing affects profitability, and where costs may need to be adjusted. Looking at the percentage also makes it easier to compare results over time or against industry benchmarks.

Even though the formula is simple, applying it in a way that supports growth takes planning. At USA Tax Gurus, we help business owners like you use gross margin as part of a broader financial strategy. From reviewing costs to adjusting pricing, we provide guidance that turns a percentage into insight. If you’re ready to improve profitability and plan for the future, please fill out a contact form or call 213-204-8737 today.

FAQs About Gross Margin

Gross margin can raise questions, especially if you’re new to analyzing business performance. Here are some common questions business owners ask.

What Is a Good Gross Margin for a Small Business?

It depends on your industry. Retail businesses may see margins around 25–35%, while service businesses often reach 50% or higher. Comparing your margin to industry averages is the best way to know if you’re on track.

Can Gross Margin Be Negative?

Yes. A negative margin means your COGS is higher than your revenue. If that happens, you’re losing money on each sale and need to review costs or pricing right away.

How Often Should I Calculate Gross Margin?

Many businesses calculate it monthly or quarterly. Frequent tracking helps you spot trends early and adjust before small problems grow.

Is Gross Margin More Important Than Net Margin?

Both matter, but they tell different stories. Gross margin shows how efficiently you produce or deliver goods, while net margin reflects your final profit after all expenses.

What’s the Difference Between Gross Margin and Markup?

Gross margin looks at profit as a percentage of revenue, while markup is profit expressed as a percentage of cost. For example, if an item costs $50 and you sell it for $100, the markup is 100%, but the gross margin is 50%.