Glossary
What Is Gross Margin?
Updated · Team Fonda
Short answer
Gross margin is the percentage of your revenue that is left after you subtract the direct costs of making or delivering what you sold, known as cost of goods sold (COGS). The formula is (revenue - COGS) / revenue x 100.
Key takeaways
- Gross margin % = (revenue - COGS) / revenue x 100.
- COGS includes only costs that exist because of the sale: materials, production labor, shipping, payment fees, hosting.
- Gross margin is what pays for rent, marketing, salaries and profit.
- Margin and markup are different numbers. Margin divides by price, markup divides by cost.
What gross margin means in plain words
Every sale brings in money and uses some up straight away. If you sell a cake, the flour, butter, box and the baker's time are gone. Gross margin tells you what fraction of the sale price survives that first round of costs. It is the money available to run the rest of the business.
The amount in dollars is called gross profit. Gross margin is the same thing as a percentage, which lets you compare products, months and business models of different sizes.
How to calculate gross margin
Formula
Gross profit = revenue - cost of goods sold. Gross margin % = gross profit / revenue x 100.
| Usually in COGS | Usually not in COGS |
|---|---|
| Ingredients, materials, stock bought for resale | Rent for your office |
| Wages of people who make or deliver the product | Marketing and advertising |
| Packaging and shipping to the customer | Your accounting and legal fees |
| Payment processing fees | Salaries of management and sales staff |
| Hosting and support costs for software | Product research and development |
Accounting rules for what belongs in COGS vary by country and industry. Ask an accountant how to classify your costs.
The free profit margin calculator works this out from your revenue and costs.
A worked example
These are example numbers. Say your home bakery sells $10,000 of cakes in a month. Ingredients cost $2,600, boxes $400 and a part-time baker $1,000.
- COGS: $2,600 + $400 + $1,000 = $4,000.
- Gross profit: $10,000 - $4,000 = $6,000.
- Gross margin: $6,000 / $10,000 x 100 = 60%.
Sixty cents of every dollar is left to cover kitchen rent, insurance, marketing and your own pay. If those fixed costs come to $4,500 a month, you keep $1,500. If they come to $7,000, the bakery loses money even though every cake is sold above its cost.
Gross margin vs markup vs net margin
| Measure | Formula | Cake that costs $4 and sells for $10 |
|---|---|---|
| Gross margin | (price - cost) / price | 60% |
| Markup | (price - cost) / cost | 150% |
| Net margin | Profit after all costs / revenue | Depends on fixed costs |
Confusing margin with markup is a classic pricing error. Adding 60% to a $4 cost gives a $6.40 price and a margin of only 37.5%. To convert between them, use the markup calculator.
Why it matters for a first-time founder
Gross margin shows up the first time you set a price, which is well before launch. It shapes what kind of business you are building. A product with a thin margin needs a lot of volume and tight cost control to pay its fixed costs. A product with a wide margin leaves more room for marketing and mistakes. Neither is wrong, but the plan for each is different.
It also feeds other numbers you will need. The revenue you need to reach your break-even point is roughly your fixed costs divided by your gross margin percentage. In the bakery example, $4,500 / 60% = $7,500 of sales a month. Your unit economics and customer lifetime value both use it. And it belongs in the financial chapter of your business plan. If you want to see how a full plan is laid out, Fonda's business plan page has example plans you can read, with 10 chapters and cited sources.
Common mistakes
- Leaving your own labor out. If you make the product yourself, cost your time at what you would pay someone else. Otherwise the margin vanishes on the day you hire.
- Forgetting small per-sale costs. Payment fees, packaging, refunds and wasted stock all belong in COGS.
- Mixing fixed costs into COGS. Rent does not change with one more sale. Putting it in COGS hides how each sale really performs.
- Pricing from cost alone. Margin is a result of what customers will pay as well as what the product costs. Test the price with real buyers.
- Checking it once. Supplier prices and discounts move. Recalculate when either changes.
Frequently asked questions
What is a good gross margin?
It depends on the industry. Businesses that sell physical goods or food carry real costs in every sale, while software and digital products have very low direct costs. Compare yourself with businesses of your own type, and make sure the margin is large enough to cover your fixed costs at a realistic sales volume.
Is gross margin the same as gross profit?
They describe the same thing in different units. Gross profit is an amount of money, such as $6,000. Gross margin is that amount as a percentage of revenue, such as 60%.
How can I improve my gross margin?
There are two levers: raise the price or lower the direct cost. In practice that means testing a higher price, negotiating with suppliers, buying in larger quantities, cutting waste, or dropping products that sell at a poor margin.
Can gross margin be negative?
Yes. If the direct cost of a sale is higher than its price, gross margin is below zero and each sale loses money before any overheads. That needs fixing before you spend on growth.