Working it out
- Revenue. Sales for the month, leaving out VAT.
- Cost of sales. What it cost to deliver what you sold: materials, goods you resold, delivery staff and subcontractors.
- Leave out overheads. Rent, admin and marketing are not cost of sales.
- Divide. Revenue minus cost of sales, divided by revenue.
If you deliver the work yourself and take no pay, cost of sales can be close to zero and this number says little. Look at net margin instead.
An illustration
The figures are invented to show the arithmetic. They are not what any business should expect.
| Revenue | R200 000 |
| Cost of sales | R120 000 |
| Gross profit | R80 000 |
| Gross margin | 40% |
Each R1 of sales leaves R0.40 to cover overheads and profit. If cost of sales rises to R130 000 on the same sales, the margin falls to 35%.
Read it against your own situation
- Last month. Is the margin rising, flat or falling?
- The price you set. Is it the margin you priced for?
- Break-even. A lower margin means you need more sales to cover your costs. See break-even.
What a change could be revealing
| The signal | It could be revealing | Check | You could |
|---|---|---|---|
| Fell in one month | A supplier price rose, a large discount was given, or a low-margin job went through | Cost per unit and average selling price, against last month | Update your prices, or renegotiate the cost that moved |
| Sliding slowly | Supplier costs rising and not passed on, or discounts becoming routine | Your prices against your current costs, product by product | Raise prices on the products that slipped most |
| Rose sharply | A supplier invoice may be missing from the accounts, or the mix moved to higher-margin work | That every supplier invoice is captured | Confirm the cost figure is complete before relying on the rise |
| Sales up, margin down | Growth may be coming from discounting or lower-margin products | Margin by product or by customer | Decide which sales are worth having |
| Swings widely from month to month | Costs may be booked in a different month from the sales they belong to | When your bookkeeper records costs | Match each cost to the month of its sale |
Try it
Your accounting software's income statement shows revenue and cost of sales. Divide the gross profit by revenue.
Questions people ask
What is a good gross margin?
There is no single figure. Compare it with last month and with the margin you priced for.
How is it different from net margin?
Gross margin ignores overheads. Net margin counts every cost.