Gross margin

Gross margin is the money you have left after paying the direct costs of what you’ve sold (materials, merchandise, production labour), but before other expenses such as rent. It is often expressed as a percentage of sales; it shows whether your business generates enough revenue to cover the rest.

At a glance

Sales minus the direct cost of goods sold
Often expressed as a percentage of sales, for example, 40%
It’s what’s left over to pay rent, administrative expenses, and, in the end, your profit
A declining gross margin often indicates a problem with prices that are too low or costs that are too high
Every percentage point of margin adds up quickly: on $500,000 in sales, an extra 1% margin means $5,000 more in your pocket

Why it matters

Think of gross margin as what’s left in your pocket after paying for the direct costs of the sale. If you make $200,000 in sales and those sales cost you $120,000 in materials and merchandise (the Cost of Goods Sold), you have $80,000 left, or 40%: that’s your gross margin. It’s with this $80,000 that you generate the first line of profit for your income statement, from which you then pay rent, office salaries, and everything else. A margin that’s too thin also slows down your break-even point. If this percentage drops from one month to the next, your prices or purchase costs are getting out of hand; you can compare it to industry averages using the Financial Performance Data from the Government of Canada. Bankeo provides you, for free, with a vetted accountant/CPA who monitors it and compares it to your industry, and we’re here to support you every step of the way.

Frequently asked questions

What exactly is gross margin?

It’s what you’re left with from a sale after paying its direct cost, before overhead expenses. For a sweater sold for $50 that cost you $30 to purchase, the gross margin is $20, or 40%.

How is it calculated?

You take your sales and subtract the direct cost of what was sold. Example: $200,000 in sales minus $120,000 in direct costs equals $80,000, or a margin of 40%.

How does it differ from net income?

Gross margin is calculated before overhead expenses (rent, administration, advertising). Net income is what’s left at the very end, after these expenses and taxes have been paid. Bankeo provides you with a free, vetted accountant/CPA to track both, and we’re here to support you every step of the way.