Gross Margin is how much money is left over from revenue after deducting the Cost of Goods Sold (COGS). Expressed as a % of total revenue, it’s the revenue left for you to pay operating expenses to keep your doors open and money to reinvest back into the business. It’s used to determine the financial health of a company.
Formula: Gross Margin (%) = (Revenue - COGS) ÷ Revenue
Revenue: Total sales
COGS: COGS is the group of expenses that support all of your revenue streams
Gross Margin can be confusing for people, but in simple terms it represents the revenue leftover after the cost of earning that revenue is subtracted.
The better your gross margin is the more you have to put back into your business to accelerate growth (e.g. Sales & Marketing spend, new product hires, etc.).
Now that you've calculated your Gross Margin, what % should you be shooting for?
Depends on who you ask:
So, maybe it doesn’t depend on who you ask - shoot for 80%
Sell more for less and keep people longer. What that means is the ways to improve gross margin are to increase revenue and decrease COGS.
The other areas have a lot more wiggle room for improvement. The ways to improve COGS are to operate lean. Review all fees and see where you can negotiate, cut costs that aren't 100% necessary, and ensure your CS team is as efficient as possible.
If you don’t have a CS team, be conscious about how you’re calculating your sales and marketing costs as some of those expenses should be in your COGS and it will affect your gross margin.
“Ask anyone in the software industry and you’ll get the same response: software companies have approximately 80% gross margins. What if we told you software costs of goods sold (COGS) aren’t always as they appear?
The answer lies in sales & marketing expense. Similar to CapEx, Growth Street breaks down S&M expense into two categories: (1) Maintenance S&M (i.e., the cost to replace churned customers) and (2) Growth S&M (i.e., the cost to grow your customer base). Call us crazy, but we put Maintenance S&M in COGS.
If you want to command a premium valuation, get churn under control and reduce your Maintenance S&M. Build your growth budget today!”
Full article here.
Gross Profit: a company’s revenues minus its cost of goods sold. This number represents the profit a company makes after paying for the costs of delivering their products or providing their services.
Gross Margin: a company’s gross margin is its gross profit described as a percentage of sales (Revenues).
“Growth solves many problems at startups, unit economics is not one of them.”
Full article here, it’s worth the read!
TL;DR: Gross Margin is how much money your business makes once direct costs are deducted. 80% is the number to shoot for, if you’re not there the ways to improve are to increase revenue while reducing Cost of Goods Sold (COGS), but then again, if you’re not at 80%, it might be helpful to scroll back up and read about how to improve your margin.