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What You Need To Know About Gross Margin

Understanding gross margin in your startup.

You’ve gained your first glimpse of customer attraction, bringing revenue into your business. 

How much of your hard-earned revenue is left over once production costs are settled? In the first years, likely not much.

Understanding how much you will have once it comes in, is what drives profitability. In a startup, numbers often measure success. One metric stands out as a powerful indicator of your financial health and growth potential: gross margin

It's not just another figure on your income statement; it's the key to understanding how efficiently your business turns revenue into profit.

This metric is vital for startups and SaaS (Software as a Service) companies competing in a crowded market.

What is Gross Margin?

Gross margin is the revenue that is left over after subtracting the cost of goods sold (COGS). It's shown as a percentage of all the money you make and tells you how much cash you have to pay to run your business. Gross margin is often misunderstood as gross profit, but this is expressed as a dollar amount ($), whereas gross margin is a percentage (%) of revenue. 

Gross Margin vs. Net Profit

While gross margin provides valuable insight into your startup's core operational profitability, it is not the same as net profit. Net profit takes into account all operating expenses, not just the direct costs of goods or services. Therefore, net profit provides a more comprehensive picture of a company's overall profitability.

Calculating Gross Margin

To calculate your gross margin, you first need to determine your COGS and revenue, which includes expenses required to provide your product or service and how much you receive from the sale. 

The formula:

Gross Margin = (Total Revenue - Cost of Goods Sold) / Total Revenue

You can find the gross margin on your income statement, one of the three main financial statements that guide your FP&A. 

Cohortly’s Gross Margin Example

Here’s an example of the gross margin of Cohortly, a B2B SaaS company:

Cohortly’s gross margin is 83% in 2023. This means that for every dollar in revenue generated by the company, they retain 83 cents as gross profit. 

In essence, they are making an 83% margin on their core operations.

However, it's crucial to note that this 83% gross margin doesn't represent the company's net profit. In reality, the remaining 18 cents of each revenue dollar must be allocated to cover various other expenses, such as marketing, CEO salaries, and overhead costs. These are not factored into the gross margin calculation.

Gross Margin = ($130,500 Revenue - $29,500 COGS) / $130,500 Revenue = 83%

Sabrina Jaffer

Experienced auditor/accountant with a passion for continuous growth and learning!