1. Definition

  • Gross Margin measures how much of a company’s revenue is left over after subtracting the Cost of Goods Sold (COGS).
  • It shows the efficiency of a company’s core operations (production, delivery) before accounting for overhead, sales, marketing, or admin costs.

It answers: “For every $1 in sales, how much do we keep after paying for what it costs to produce/deliver the product?”

2. Formula

$\text{Gross Margin} = \frac{\text{Revenue – COGS}}{\text{Revenue}} \times 100$

Where:

  • Revenue = total sales (top line).
  • COGS = direct costs of making the product or service (materials, labor, manufacturing, hosting fees for SaaS, etc.).

3. Example

  • Revenue = $1,000,000
  • COGS = $400,000

$\text{Gross Margin} = \frac{1,000,000 – 400,000}{1,000,000} \times 100 = 60\%$

Means the company keeps 60¢ per $1 of sales after covering production costs.

4. Interpretation

  • High gross margin → strong pricing power, efficient production (e.g., software companies often 70–90%).
  • Low gross margin → heavy production/operational costs (e.g., retail or manufacturing might be 20–40%).

5. Why It’s Important

  • Core profitability indicator → shows whether the business model makes sense.
  • Used to compare against industry benchmarks.
  • Basis for other metrics like Contribution Margin and Unit Economics (LTV, CAC payback).

6. Gross Margin vs. Net Margin

  • Gross Margin → Revenue – COGS only.
  • Net Margin → includes all expenses (sales, marketing, R&D, admin, interest, taxes).
  • Gross is about core operations, Net is about overall profitability.

Summary:
Gross Margin = (Revenue – COGS) ÷ Revenue.
It tells you how profitable your product/service is before overhead. Higher = better efficiency.