## What Is Gross Margin?

Your company’s gross margin indicates the difference between its revenue and the cost of goods sold (COGS). The latter includes the direct production costs and any indirect costs associated with product creation.

Sometimes called “gross profit margin,”  it is a metric that aids businesses in evaluating their operational efficiency and financial strategies.

A gross margin calculator is a tool used by businesses to determine their gross profit margin, which is a key metric in assessing financial performance.

It helps calculate the percentage of revenue that exceeds the cost of goods sold (COGS), providing insights into operational efficiency and profitability. You can check out our free calculator below.

However, there is a distinction between gross profit and gross profit margins.

Gross profit simply refers to the absolute amount a company earns after deducting its COGS. Gross profit margin, in contrast, reflects the percentage of revenue that exceeds the COGS.

Remember: gross profit is measured in dollars and gross profit margins are expressed as percentages (and are, as such, also referred to as “gross margin percentages”).

#### Key Takeaways: Gross Margin Calculator

• Essential Metric: Gross margin is crucial for evaluating a company’s profitability by measuring the relationship between revenue and COGS.
• Operational Insights: Analyzing gross margin helps businesses optimize pricing strategies, manage production costs, and make informed decisions about resource allocation.
• Comparative Analysis: Businesses can use gross margin calculations to benchmark against industry standards, track performance over time, and identify areas for improvement.
• Strategic Decision-Making: Businesses use gross margin metrics to optimize pricing strategies, manage production costs, and allocate resources effectively.
• Performance Benchmarking: Analysis of gross margin helps companies benchmark against industry standards, track performance trends, and identify areas for improvement.
• Long-Term Planning: While crucial for short-term profitability, gross margin analysis should be complemented with broader financial metrics for comprehensive long-term planning

## Gross Margin Calculator

Ready to start using our gross margin calculator? All you have to do is enter your Cost of Goods Sold (COGS) and your net sales and hit calculate and you’ll have your answer.

## Best Practices for Using Your Gross Profit Margin

Keeping a close eye on gross margins is vital for businesses across many industries, including manufacturing, retail, and food production.

Software developers, healthcare industries, and financial services tend to have higher gross margins than others, but they can still use the metric to monitor business performance.

Business leaders can use gross margins in one of several key ways:

• To compare their businesses to industry benchmarks
• To optimize their pricing strategies
• To reduce their COGS

## When Is Gross Margin Analysis Most Critical for Businesses?

The following situations can be ideal times to use a gross margin calculator to measure the efficiency of your business:

• When trying to assess the impact of inflation on profits
• When making decisions about how to allocate company resources
• When determining the return on investment (ROI) of a new product or service
• When providing a snapshot of your business to lenders or investors

Pro Tip: When you need to secure new funding for your business, lenders will want to see your gross margin alongside several other core business metrics. Preparing your gross margin can increase your chances of securing a favorable small business loan.

You don’t need to be a math whiz to calculate gross margins. Aside from using a gross margin calculator, you can simply use the following formula to determine your gross profit margin:

Gross margin = (Net sales – COGS) / (Net sales)

## How to Calculate Your Gross Margin

As an example, imagine that your company earns \$30,000 in net sales but spends \$20,000 on the COGS. Applying the formula, you can calculate your gross margin as follows:

Gross margin = (\$30,000 – \$20,000) / (\$30,000)

In this case, your gross margin would be roughly 33%. If you are a retailer, that would exceed the industry benchmark of 24.27%. Thus, your gross margin might point you toward adjusting your price point to be more competitive.

### Gross Margin Calculator

Use this tool to quickly calculate your gross margin and gain valuable insights into your business’s financial performance:

• Comparing your gross margin to industry benchmarks, as seen in the example above
• Evaluating your operational and production costs to increase your gross margin
• Assessing your current pricing strategies
• Tracking your gross margin over time to see how production costs impact profits

That last suggestion might be especially useful for growing businesses. Ideally, you’ll want to see your gross profit margin rise with time. A declining profit margin may indicate problems in your production model or supply chain, which may require a new strategy.

### Practical Applications for Gross Margin Analysis

Consider two scenarios where the gross margin becomes significant for your business decisions.

In the first, you calculate your gross profit margin and discover that your profit margins are unusually high for your industry.

That seems great (and it certainly could be) but if it doesn’t match up with greater-than-average gross profits, it may indicate that your selling price is too high. A high selling price naturally yields a greater profit margin but may limit your sales volume. Adjusting your price point can help you compete with other businesses and generate more revenue through higher sales.

In the second scenario, you discover that your gross margin is lower than current industry standards or your prior years’ data.

That may point to a higher COGS, which may reflect the cost of production itself or the indirect costs associated with distribution.

Therefore, a low gross margin may prompt you to reevaluate your supply chain or procurement process to bring costs down and improve your gross margin.

## Examples of Calculating Gross Margin

How does gross margin impact businesses in the real world? Consider the following two examples that illustrate the importance of gross profit margin.

### Case Study 1: New Startup

First, consider the case of Theresa’s newly-launched business, which manufactures and sells athletic wear. Her total sales revenue for the year came to \$120,000, but after subtracting discounts and fees, her net sales fell to \$95,000. Meanwhile, her COGS came to \$85,000.

Theresa inputs her figures into the gross margin formula and determines that her gross margin is:

Gross margin = (\$95,000 — \$85,000) / (\$95,000)

In other words, Theresa’s gross margin comes to a scant 10.5%. Most retail businesses see a gross margin of 24.47% or better. Comparing herself to that industry benchmark, Theresa was compelled to raise the price of some of her best-selling apparel while adjusting her marketing strategy to emphasize the value her customers receive.

### Case Study 2: Large Enterprise

DigiGraphics is a software company that provides software-as-a-service for small to midsize businesses. Each year of operation, the company reviews its income statements and sales figures and calculates its gross profit margin.

The company’s net sales totaled \$150,000 this year, while its COGS had fallen to just \$45,000.

Thus, its gross profit margin came to the following:

Gross margin = (\$150,000 — \$45,000) / (\$150,000)

That means the company had achieved a high gross margin percentage of 70%. Most software companies aim for a gross margin of 58.58%.

The high margin gave DigiGraphics room to introduce a new pricing tier for entry-level customers, allowing the company to provide more value to certain customers. Doing so may have dropped their gross margin, but it allowed them to onboard more first-time users.

## Gross Margin vs. Net Margin

Gross and net margins can both be used to evaluate a company’s profitability, but these metrics have some key differences. Gross margin reflects the company’s revenue remaining after accounting for the COGS.

On the other hand, a net profit margin reflects your net income after accounting for all business expenses such as taxes, interest on debt, and other operating costs.

### Strategic Implications of Net Margin Over Gross Margin

As you can see, net profit margins offer a far more comprehensive picture of company operations.

Businesses can, therefore, use their net margins to evaluate the performance of the companies as a whole. A low net margin, for example, might cause a company leader to evaluate more than just their COGS and work toward eliminating debt or reducing their tax burden through strategic deductions.

### Using Gross Margin Over Net Margin

Your gross margin will be more helpful in evaluating the true profit percentage of your core sales activities.

But when you want to zoom in on the efficiency of your pricing model, gross margin is generally the ideal choice. However, if you want to evaluate the financial performance of your business more holistically, net margin will incorporate more data.

## Tips to Optimize Gross Margin

Optimizing your gross margin demands the right strategy. With that in mind, business leaders can attenuate their gross profit margin using one of the following categories of techniques:

### Cost Management Techniques

When your gross margin falls above industry benchmarks, you might take steps to manage costs, such as:

• Sourcing materials from new suppliers
• Negotiate for lower material costs
• Diversifying your supply chain to reduce shipping costs
• Outsourcing assembly or production
• Relying on more affordable materials

Just make sure not to reduce your material costs in a way that harms the quality of your product, as that could result in lower sales in the long term.

### Price Optimization

Business leaders should usually work toward optimizing their prices to align their gross margins with industry standards. For example, raising the price of your products can ensure a stable gross margin, though you may need to ensure that consumers understand how the quality of your products justifies the new price point. Check out the average gross margin and net margin of some of the largest industries below.

Alternatively, you could lower your prices to remain competitive. You may see your profit margins decrease (while staying within industry standards), but you will likely achieve a higher sales volume overall.

### Process Improvement Initiatives

Another way to optimize your gross margin is through process improvement initiatives designed to address the indirect COGS. You might consider how logistics partners might lower costs by outsourcing picking, packing, or distribution costs. As another option, you may seek ways to increase production volume to get more of your products onto the market.

## Common Pitfalls to Avoid

Despite the benefits of your gross margin, it’s important not to overlook additional variables that can impact your final numbers. These include things like:

### Overlooking Variable Costs

Your COGS won’t always reflect a fixed cost. Supply chain delays and changes in the price of supplies can radically alter the final amount. Ignoring these variables can alter your gross margin data and distort your view of your company’s profitability.

### Ignoring Market Dynamics

Market trends can radically alter your gross margin. Sales volume and customer sentiment can change over time, and some products may experience cyclical consumer trends. These dynamics can result in different gross margins over a single year.

Fun Fact: profit margins of US nonfinancial companies have nearly doubled in just the last few years according to a recent Bloomberg report.

### Short-Termism vs. Long-Term Value

Today’s gross margin doesn’t always predict tomorrow’s success.

## What Is the Difference Between Gross Margin and Gross Profit?

While often used interchangeably, gross margin and gross profit are distinct metrics in assessing a company’s financial performance:

• Gross Margin: Represents the percentage of revenue that exceeds COGS, providing insights into operational efficiency and profitability.
• Gross Profit: Indicates the dollar amount remaining after subtracting COGS from revenue, offering a measure of profitability before considering other expenses.