Gross Margin (GM) measures the percentage of revenue that exceeds the Cost of Goods Sold (COGS).
This metric highlights the cost structure of your core services and is important to understand how much revenue you retain after incurring the direct costs associated with delivering your product. It's essentially a measure of how efficiently you use labour and supplies in the production process. It's used to evaluate the scalability and underlying profitability of your company. Gross Margin is particularly useful for price-setting, cost management, forecasting the Break-Even Point, and informing if unit economics are viable for scaling a business.
(Revenue - COGS) / Revenue x 100
To calculate Gross Margin, subtract the Cost of Goods Sold (COGS) from your revenue, and then divide this result by your revenue. Multiply the outcome by 100 to get a percentage.
To effectively use GM, scrutinise COGS components regularly to identify potential savings. Ensure overheads and 'nice to haves' are excluded from the calculation; only consider the costs that are essential to deliver your product or service.
One error is confusing Gross Margin with Net Profit Margin (NPM). NPM is the percentage of revenue remaining after all operating expenses, interest, taxes, and preferred stock dividends have been deducted from your total revenue. It reflects the overall profitability of your company.