As a small business owner, it can feel pretty satisfying to see the revenue pouring in as your retail business starts to take off. However, it’s important to keep an eye on how much you’re spending to keep your business afloat. Gross margin acts as a way for you to benchmark your business and assess your success and financial health. You can use this metric to help identify how much you can reinvest into your business, pay off debts, and where the break-even point is.

What is gross margin?

By definition, gross margin is the amount of money left after your business produces its products or sells its services. It’s the profit earned for every dollar spent making an item or a service possible. It’s important to note that only production costs are included in this formula, so it shows how much profit is available to cover fixed costs and other non-operating expenses. The higher your gross margin, the better your business is doing financially. 

It costs money to produce products and services. The expenses that are included for producing a product or service include raw materials, labour and delivery. This total expense is the total amount of cost of goods sold (also known as COGS). This is one of the necessary variables needed for calculating gross margin. 

You calculate it by looking at your total revenue and comparing it to the costs of the goods you’ve sold. This idea seems simple enough, but this basic calculation lends valuable insight into how your company is doing.

Many factors contribute to your gross margin: customer loyalty, product differentiation, industry competition, and scarcity of materials to make your products. If you’re gauging your gross margin, you’re looking at dozens of variables that influence your company.

How to calculate gross margin

The formula for gross margin is as follows:

Gross margin % = (Total revenue - COGS)/Total revenue x 100

Calculate your total revenue

First thing’s first, determine your company’s total revenue. This includes any purchase discounts you’ve offered clients as well as factoring in any products your client has returned. Calculate total revenue with this formula:

Total revenue (TR) = quantity (Q) x price (P)

Calculate your COGS

Next, figure out your total cost of goods sold. If you’re using a cash basis of accounting, this is your current period spend on inventory. If you’re using an accrual basis of accounting, you can choose between the FIFO, LIFO, or average cost methods to calculate cost of goods sold.

The COGS formula is:

COGS = beginning inventory + purchases during the period - ending inventory

Subtract cost of goods sold from revenue. This difference is your gross profit in dollars, and it represents the amount of money your company has earned before selling, administrative, interest, or tax expenses.

Divide your gross margin in dollars by your total revenue to discover your gross margin percentage. If your total revenue last year was $100,000 and your total cost of goods sold was $40,000, your gross profit is $60,000 and your gross margin is 60%, or $60,000 divided by $100,000. This means for every dollar of sales, you earn 60 cents to cover fixed costs, research and development, capital investments, and more.

Key takeaways

The gross margin metric is a straightforward measurement as  it tells you a lot about how your company is doing. Leverage QuickBooks to calculate your figures for you, so you have more time to analyze the results. Join the millions of customers who use QuickBooks and help your business thrive for free.