Gross margin is the revenue that is left after subtracting the cost of products sold. It is expressed in terms of a percentage of the total revenue. It is simply the money or amount you have to cover the operating expenses and reinvest back into your business.
It is mandatory for startups to keep an eye on their gross margins. A high gross margin means you can grow your business quickly as you have more cash on hand to spend on the growth and development of your form.
In this blog, we will cover how to calculate gross margin, how to improve it, what is a good gross margin, and many more.
How Do You Calculate Gross Margin?
Before you head towards calculating the gross margin, you need to know the cost of goods sold (COGS). COGS includes all types of expenses required to provide your product or service to the users. Hosting, support cost, and 3rd party integration fees are also included in it.
Once you know the monthly cost of goods you sold, you can find the gross margin. To do so, you have to divide the difference of MRR and COGS by revenue.
Gross Margin Formula
Gross Margin % = Revenue-COGS ÷ Revenue = Gross Profit÷Revenue×100
Example: Consider you sold a pen for $10 when its cost is $3. It means you are having a gross margin of $7 for every pen.
Gross Margin = ($10-$3)/$10 = 70%
Frequently Asked Questions (FAQs)
What is the difference between gross margin and net margin?
Gross margin is the profit after subtracting the COGS from the total revenue generated by selling a product or service. On the other hand, net margin is the profit you have after subtracting all the expenses including taxes and operating expenses.
Net margin gives a more comprehensive idea of profit as it is left after subtracting all types of expenses. On the other hand, from the gross margin, only COGS is excluded.
What’s a “Good” Gross Margin for a SaaS Company?
Basic mathematics applies there. If you want to make money, you have to sell your products at a value higher than their cost. The more margin you keep on each product the better.
You need a higher gross margin to grow your business. A higher gross margin indicates that each $ 1/ of your revenue is more profitable for your business.
Let’s compare two companies A and B both having 10% and 80% gross margin respectively. So company A will have only 10 cents per dollar to invest in the business. On the other hand company B will have 80 cents per dollar to invest in the business.
Having a higher gross margin is a huge advantage in terms of marketing and R&D spending. Now you know why a company with $10 million in revenue can be more successful than a company with $20 Million in revenue.
What are Some Benchmarks for SaaS Gross Margins?
According to industrial research and data analytics, the gross margin for SaaS companies is around 73%. However, this figure can vary greatly depending on the nature of your business and your strategies. For example, enterprise companies have higher gross margins than non-enterprise companies.
Most VCs and SaaS experts suggest that SaaS companies must strive for a gross margin of approximately 80%.
How Can a SaaS Company Improve its Gross Margin?
There are two ways to increase gross margin:
- Increase Revenues
- Decrease COGS
In the beginning, your gross margin can be lower because your business is not profiting from the economies of scale. As you keep on acquiring new subscribers, it becomes less expensive to support each one. As a result, your gross margin improves.
You need to continuously decrease your COGS and increase revenue to improve gross margins. However, you need to maintain balance. Having a low-quality product to reduce COGS or selling them at too expensive rates can leave you with a low count of customers.
A 50% gross margin on a $1000 business is far better than a 90% gross margin on a $500 business.
