Last updated: March 2026
Understanding Gross Margin
Gross margin measures the profitability of your core business operations before overhead costs. It answers: how efficiently do you produce or acquire the goods you sell? A high gross margin gives you more room to cover operating expenses and invest in growth.
The formula is simple: (Revenue \u2013 COGS) \u00F7 Revenue \u00D7 100. If you sell a product for $100 and it costs $40 to produce, your gross margin is 60%. That $60 gross profit must then cover rent, salaries, marketing, and everything else.
Gross Margin vs Net Margin
Gross margin deducts only direct costs (COGS): raw materials, direct labor, and manufacturing overhead. Net margin deducts everything: COGS plus operating expenses, interest, taxes, depreciation, and amortization.
A software company might have an 80% gross margin (low COGS since code doesn't have material costs) but only a 15% net margin after accounting for developer salaries, servers, marketing, and office space. Both metrics are essential \u2014 gross margin shows production efficiency, net margin shows overall business health.
Frequently Asked Questions
What is gross margin?
Gross margin is the percentage of revenue remaining after subtracting the cost of goods sold (COGS). It’s calculated as (Revenue – COGS) ÷ Revenue × 100. A gross margin of 60% means 60 cents of every revenue dollar is available to cover operating expenses and profit.
What is the difference between gross margin and net margin?
Gross margin only deducts direct costs (materials, direct labor, manufacturing). Net margin deducts everything: COGS plus operating expenses, interest, taxes, and depreciation. A company might have a 60% gross margin but only a 10% net margin after all expenses.
What is a healthy gross margin?
Software/SaaS: 70–85%, consulting: 50–70%, manufacturing: 25–35%, retail: 25–50%, restaurants: 55–65% (on food), grocery: 25–30%. Compare within your industry, as gross margins vary dramatically across sectors.
How do I improve gross margin?
Increase prices, negotiate lower costs from suppliers, reduce waste and shrinkage, optimize production efficiency, switch to higher-margin products or services, or implement value-based pricing instead of cost-plus pricing.
What is COGS (Cost of Goods Sold)?
COGS includes all direct costs to produce or acquire the goods you sell: raw materials, direct labor, manufacturing overhead, and shipping to your warehouse. It does NOT include indirect costs like marketing, rent, or administrative salaries — those are operating expenses.
Can gross margin be negative?
Yes. A negative gross margin means you’re selling products for less than they cost to produce. This can happen with loss leaders (intentionally below-cost items), during liquidation, or if costs spike unexpectedly. It’s unsustainable long-term.