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What is gross margin, and how do I calculate it?

Prepared by the Flawian team · Reviewed .

Gross profit is sales minus the cost of what you sold. Gross margin is that gross profit as a percentage of sales. A repair shop with $12,000 of sales and $7,800 of parts and work on those repairs keeps $4,200, a gross margin of 35%.

Principle and explanation

The cost of what you sold is everything spent to provide those sales: materials, purchase price, outside work and your own staff's time on those jobs. Stock bought for later stays out. A sale is one order a customer pays for.

Markup, margin and contribution

Markup compares gross profit with the cost of what you sold; margin compares it with sales. The repair shop's $4,200 is a 53.8% markup on $7,800 of cost and a 35% margin on $12,000 of sales. Margin shows what share of each sale stays; markup shows how much was added to cost. Contribution, in the break-even chapter, subtracts only the costs that change with each sale, such as materials and per-sale fees, not fixed wages. So it can be higher or lower than gross profit.

Worked example

Illustrative scenario. These are fictional inputs, not customer results.

In one month a repair shop's customers paid $12,000 for 150 repairs; a café took $18,500 from 3,700 orders. Amounts leave out sales tax you only collect and pass on to the state.

Gross profit and gross margin of two fictional businesses in one month
Repair shopCafé
Sales in the month$12,000$18,500
Cost of what was sold$7,800$6,290
Gross profit$4,200$12,210
Gross margin35%66%
Number of sales1503,700
Gross profit per sale$28$3.30

The café keeps the larger share of each sale; the repair shop keeps the larger amount per sale.

Try it with your own numbers

$

What customers paid, after returns and discounts, without sales tax you only collect and pass on to the state.

$

Only the cost of the goods or work in those sales, such as their materials or purchase price. Not stock bought for later.

Orders customers paid for in the period.

Your result

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Method

Gross profit = sales − cost of what you sold: $12,000 − $7,800 = $4,200.

Gross margin = gross profit ÷ sales × 100: $4,200 ÷ $12,000 × 100 = 35%.

Gross profit per sale = gross profit ÷ number of sales: $4,200 ÷ 150 = $28.

Special cases:

  • When the cost of what you sold exceeds sales, gross profit is a loss and the margin falls below zero.
  • With no sales there is no margin, only costs not covered.
  • Without a count of sales there is no amount per sale.

What this does not show

  • It is not profit: rent, wages and other costs that do not come with a sale still come out of it.
  • It is not cash: customers may pay later, and stock bought for later has already used cash.
  • It sets no target: whether a margin is enough depends on your other costs.

First step

From last month's invoices and supplier bills, take sales after returns and discounts and the cost of what those sales used up. Work out the margin, then find how many sales cover your fixed costs.

Sources