Gross margin: What it is, how to calculate and improve it

Published Monday 22 December 2025

Table of contents

• What is gross profit margin?
• Why gross profit margin matters for your business
• Gross profit margin vs gross profit
• How to calculate gross profit margin
• Analyzing gross profit margin for business insights
• What is a good gross profit margin?
• Gross profit margin compared with other metrics
• How to improve gross profit margin
• Track your gross profit margin with Xero
• FAQs on gross profit margin

Key takeaways

• Calculate gross profit margin by subtracting cost of goods sold from revenue, dividing by revenue, and multiplying by 100 to identify how much money remains after direct costs to cover operating expenses and generate profit.
• Track your gross profit margin trends over time to spot pricing issues, cost increases, and product performance problems early, allowing you to make informed decisions about pricing and cost management.
• Benchmark your margin against industry standards since good margins vary significantly by sector (software companies typically achieve 70-90% while retail businesses maintain 20-50%), ensuring your margin covers operating expenses, taxes, and owner compensation.
• Improve your gross profit margin by adjusting prices based on market conditions, reducing cost of goods sold through better supplier relationships and bulk purchasing, and streamlining operations to eliminate waste and automate processes.

What is gross profit margin?

Gross profit margin is the percentage of sales revenue remaining after paying direct costs. It reveals three critical insights about your business:

• Operational efficiency: How well you produce and deliver products or services
• Pricing effectiveness: Whether your prices adequately cover costs
• Financial health: Your ability to cover operating expenses and generate profit

Your gross profit margin determines how much money flows through your business operations.

High gross margins provide:

• More funds to cover operating expenses like rent and utilities
• Greater capacity for business growth and investment
• Better resilience during economic downturns

Low gross margins create:

• Difficulty covering essential business expenses
• Limited funds for growth opportunities
• Higher risk of cash flow problems

After paying operating expenses from your gross profit, the remainder becomes your net profit.

Why gross profit margin matters for your business

Think of gross margin as a health check for your products or services. It shows you how much money you make from each sale before paying for your general business expenses. A healthy margin means you have more cash to reinvest, cover costs, and grow your business.

By tracking it, you can spot which offerings are most profitable, make smarter pricing decisions, and stay on top of your financial health with confidence.

Gross profit margin vs gross profit

Gross profit and gross profit margin measure the same concept but express it differently:

• Gross profit: The dollar amount remaining after subtracting cost of goods sold (e.g., $50,000)
• Gross profit margin: The percentage of revenue that becomes gross profit (e.g., 60%)

Gross margin is another term for gross profit margin; these terms are used interchangeably in business.

How to calculate gross profit margin

Gross profit margin (calculation)

Gross profit margin formula:

Gross profit margin = (gross profit ÷ revenue) × 100

Gross profit margin formula explained

Calculate gross profit margin in two steps:

Step 1: Find your gross profit

• Take your total revenue (sales figure)
• Subtract your cost of goods sold (COGS)
• Result = Gross profit

Step 2: Calculate the margin percentage

• Divide gross profit by total revenue
• Multiply by 100 for percentage

Gross profit margin example calculation

Gross profit margin calculation example:

Imagine you run an office cleaning service.

• Revenue: $20,000
• Cost of goods sold: $8,000 (cleaning supplies, labour)
• Gross profit: $20,000 - $8,000 = $12,000

Margin calculation:($12,000 ÷ $20,000) × 100 = 60% gross profit margin

This means you keep 60 cents from every dollar of revenue after covering direct costs.

Avoid common calculation mistakes

Avoid these common calculation mistakes:

Incorrect COGS estimation:

• Include all direct costs: materials, labour, shipping
• Exclude indirect costs: rent, marketing, administrative expenses
• Update COGS regularly as supplier prices change

Revenue timing errors:

• Match revenue with corresponding COGS in the same period
• Account for returns and discounts in revenue calculations

Make sure you estimate your COGS correctly, as it strongly affects the gross profit margin calculation.

Analyzing gross profit margin for business insights

Gross profit margin analysis can help you understand the profitability and performance of each part of your business, so you know where you need to improve.

Competitively pricing your products can increase sales, while managing costs (which eat into your profit margins), will help to boost your margin.

Interpreting gross profit margin trends

Monitor your gross margin trends over time to reveal patterns in your business's performance, such as where your revenue is strong (and where it isn't), and how your costs change by product and time of year.

Factors affecting gross profit margin

External factors affecting your gross profit margin:

Market demand changes:

• High demand allows premium pricing and higher margins
• Low demand forces price reductions to maintain sales volume
• Seasonal fluctuations impact both pricing and sales

Supplier cost increases:

• Rising material costs directly reduce margins
• Labour cost inflation affects service-based businesses
• Supply chain disruptions increase procurement expenses

Customer spending power:

• Economic downturns reduce customer budgets
• Inflation affects customer purchasing decisions
• Competition may force price matching

What is a good gross profit margin?

A good gross profit margin varies by industry and business type. Most healthy businesses maintain margins between 50-70%, but this depends on several factors:

Industry standards:

• Software companies: 70-90%
• Retail businesses: 20-50%
• Restaurants: 60-70%
• Manufacturing: 25-35%

Your margin must cover:

• Operating expenses (rent, utilities, salaries)
• Business growth investments
• Tax obligations
• Owner compensation

Factors affecting your margins

Several key things influence how 'good' a gross profit margin might be:

• Industry: Different industries have different cost levels and structures that affect margins. Hospitality, for instance, has high overhead costs and relatively low product costs, while financial services have lower overhead costs and higher service fees.
• Region: Costs, expenses, and market forces vary wildly between regions. For instance, some countries have higher or lower taxes, and a big-city shop gets more footfall than a shop in a small village.
• Business type: Ecommerce stores typically have lower overhead costs and more scope for sales than traditional retailers, and therefore potentially higher margins.
• Market competition: The forces of competition in industries like electronics retail drive down prices, squeezing profit margins.

Benchmarking your gross profit margin

For a realistic picture of how your business is performing within your industry, benchmark your business against competitors in your industry.

You'll get the clearest picture of your gross profit margin if you benchmark it against similar-sized businesses that operate in the same industry, market or region.

Industry benchmarks for gross profit margin

Gross profit margins can vary significantly in different sectors. For example, jewellery and cosmetics industries often achieve margins over 55%. By contrast, industries such as electronics and alcoholic beverages may operate with margins below 45%. These differences reflect the unique environments of each industry.

Your accountant or bookkeeper can help find gross profit margin benchmarks for small to medium-sized businesses (SMBs) in your industry, and help clarify what your business should be aiming for.

When to reassess your gross profit margin

Evaluating and monitoring your gross profit margins is especially important in a changing market (when your costs might rise). It's also good to look at them when conducting a financial performance analysis; for example, if you've missed your growth targets.

Your gross profit margin needs to cover the costs of selling your products or services (your COGS) and other costs like operating expenses and taxes. Your accountant can help you pinpoint a gross margin for your business.

Xero's accounting software automatically calculates your gross profit margin and provides real-time insights into your business performance. You can monitor trends, compare periods, and identify opportunities for improvement without manual calculations.

Gross profit margin compared with other metrics

Here's a quick comparison of the main differences between gross profit margin and two other business metrics, and how to use each one to work out the profitability of your business.

Gross profit margin vs operating profit margin

While gross profit margins only consider the cost of goods sold (COGS), operating profit margins are the next step in analyzing revenue vs profit, as they also account for other operational costs like rent and utilities.

Gross profit margin vs net profit margin

Net profit margin goes a step further than the operating profit margin. Net profit margin shows your overall financial health, after taking into account your operating costs, as well as interest and taxes. It's the "bottom line" profit.

How to use each metric

Use your:

• gross profit margins to analyze your COGS and to make pricing and resource allocation decisions
• operating profit margins together with your gross profit margins to guide your pricing, resource allocation and budgeting
• net profit margins for long-term financial planning, as businesses with consistently high net profit margins are more resilient to economic changes

How to improve gross profit margin

Small business owners can take clear, practical steps to strengthen their gross profit margins.

1. Adjust your prices

Review and update your prices as market conditions change. For instance, if a competing product is cut in price, you may need to change your own prices to prevent a dip in sales. Also think about improving your products or services to support higher pricing and improve margins.

2. Reduce your cost of goods sold

Your costs eat into your gross profit margin, so watch them closely. Find affordable suppliers and develop your relationships with them: you might get bulk discounts and better rates, improving your long-term costs.

3. Streamline your operations

Reduce waste and automate your processes (for example, by using accounting software) to cut costs and boost profit margins. For instance, effective inventory management can minimize excess stock, bringing down storage costs.

Track your gross profit margin with Xero

Xero helps you stay on top of your financial metrics as a small business owner. It makes it easier to follow your gross profit margin, and all business financial metrics, so you have more time to plan for your success.

Try Xero for free.

FAQs on gross profit margin

Still have questions about gross margin? Here are answers to some common queries.

What does a 20% gross margin mean?

A 20% gross margin means that for every dollar of revenue, your business keeps 20 cents as gross profit after covering the direct costs of the goods or services sold. You use the remaining 80 cents to pay for those direct costs.

Is a gross margin of 70% good?

A 70% gross margin is generally considered very healthy for many industries, like software, retail, or restaurants. However, what counts as 'good' depends on your specific industry, business size, and market conditions. It's best to compare your margin to your industry's benchmarks.

What's the difference between gross margin and markup?

Gross margin shows profit as a percentage of your revenue (profit ÷ revenue), while markup shows profit as a percentage of your cost (profit ÷ cost). Margin tells you how much of each dollar in sales is profit, whereas markup tells you how much you've increased the price from its cost.