Gross Margin
Quick Answer: Gross margin is gross profit divided by revenue—an input to profitability and ROI when revenue-based marketing metrics are converted to profit.
Gross margin is the percentage of revenue remaining after deducting cost of goods sold (COGS). It measures the profitability of products or services before accounting for operating expenses. Higher gross margin indicates stronger unit economics and more room to cover fixed costs and generate net profit.
This page provides a structured explanation of gross margin and profitability, including formulas, examples, limitations, and comparisons with related financial metrics.
When to Use This Calculation
- Converting revenue-based ROI to profit-based ROI
- Benchmarking product economics
- Stress-testing price and COGS
Limitations of This Metric
- Excludes operating and capital costs
- Definitions of COGS vary by industry
- Not a complete picture of cash generation
What Is Gross Margin?
Gross margin is the percentage of revenue remaining after subtracting cost of goods sold (COGS), before operating expenses.
Formula
Gross Margin = [(Revenue − COGS) / Revenue] × 100
Or: Gross Margin = (Gross Profit / Revenue) × 100. COGS includes direct costs of producing or delivering the product (materials, labor, shipping for goods). It excludes selling, general, and administrative (SG&A) expenses.
Example
A company has $500,000 in revenue and $300,000 in COGS. Gross profit = $200,000. Gross margin = ($200,000 / $500,000) × 100 = 40%. For every dollar of revenue, 40 cents remains after direct production costs.
Relationship to LTV and ROI
In LTV calculations, gross margin (as a percentage or decimal) is applied to revenue to estimate profit per customer. LTV formulas often use ARPU × Gross Margin to get gross profit per user. Higher gross margin increases LTV and improves the return on customer acquisition. Gross margin also affects net profit and thus ROI on business investments.
Gross Margin vs. Net Margin
Gross margin considers only COGS. Net margin (net profit / revenue) deducts all expenses including SG&A, interest, and taxes. A business can have high gross margin but low or negative net margin if operating expenses are large. See net profit and EBITDA for related metrics.
Caveats
COGS definition varies by industry. Software companies may have minimal COGS; retailers have significant inventory and shipping costs. Allocation of shared costs to COGS can affect the result. Gross margin should be compared within similar business models.