Keeping track of your business’s gross margins is essential to its long-term success. It reflects your business’s profit potential, so the higher your gross margin, the more profit you generate per sale. As a business owner, though, you might be wondering why exactly gross margin is important as well as how to calculate it.
A General Overview of Gross Margin
The term “gross margin” refers to your business’s net sales minus your business’s cost of goods sold (COGS) and divided by your business’s total revenue. In other words, it’s a measurement of how much profit your business generates. The key difference between gross margin and profit margin is that the former is expressed as a percentage, whereas the latter is expressed as a dollar amount. Other than this subtle nuance, both financial terms refer to profit.
How to Calculate Gross Margin
To calculate gross margin, take your business gross profits and divide it by your business’s revenue. You can then convert this figure into a percentage by multiplying it by 100.
Let’s say your business generates $100,000 in total sales revenue and spends $30,000 on COGS-related expenses like product manufacturing and employee payroll. You can calculate gross margin by taking $100,000 and subtracting it by $30,000, which equals $70,000. Next, you’ll need to divide $70,000 by $100,000, which equals $0.70, followed by multiplying that number by 100, which equals 70. Under this example, your business’s gross margin would be 70%.
Keep in mind that some businesses may have a negative gross margin. When this occurs, it means your business’s COGS exceeds its profits. It’s a troubling a sign that can hinder your business’s ability to grow or even remain operational. By calculating your business’s gross margin, though, you can make the necessary changes to prevent this from happening.
Assuming you use Quickbooks to keep track of your business’s financial transactions, you can automatically calculate gross margin within your Quickbooks account. In the Profit & Loss report, click the menu next to “Period to compare,” at which point you can select the option for “% of Income.” When you run a report using these settings, it will show a percentage for all values, including gross margin.
To recap, gross margin is a general overview of your business’s profits. It reveals the value of incremental sales, allowing you to see how much profit you earn after accounting for COGS.
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