Gross Margin, perhaps our favorite accounting metric here at BookWerksTM, is calculated by subtracting what your product or service cost you (Cost of Goods Sold, or COGS), from what you sell your product for (Revenue). We typically express this as a % of Revenue.
For example, if you sell an item for $9 that costs you $6 to produce, your gross margin on that item is $3, or 33.3 percent.
9 – 6 = 3
3 is 33.3% of 9
So your gross margin on the item is 33.3 percent.
Another way of looking at it is, you retained $0.33 from every dollar of revenue generated.
Higher Gross Margin is Better
The higher the gross margin–otherwise known as gross profit–the better.
A high gross margin gives an entrepreneur more room for error in running their business. The higher the gross margin, the more capital a company retains, which it can then use to pay other costs or satisfy debts. They can pay general and administrative expenses, interest fees and dividend distributions to shareholders.
Who has Good Gross Margins?
Gross margin varies by industry. Service-based industries tend to have higher gross margins as they don’t have large COGS. On the other hand, the gross margin for manufacturing companies are lower, as they have larger COGS.
Low gross margin businesses, like distributorships, rely on high volume revenue and keeping other costs low to turn a profit.
Good professional bookkeeping services will keep an eye on the trend in your gross margin over time, with the goal of making continuous improvement.
You can improve your gross margin through:
- less expensive materials
- less expensive labor
- more efficient production and/or
- selling at higher prices.