How to calculate your gross margin of sales
Calculate your gross margin of sales to determine how much you should put toward covering costs, as well as how much you have in actual profit.
Total sales is an important indicator of your business's success, but it's not the only one.
Your sales total shows how much money you generated, but doesn't account for the costs you incurred in making those sales, from buying materials to paying salespeople.
For a more complete picture of your business, you need to know your business's gross margin of sales, which is what's left after covering the costs of sales. Calculate your gross margin to determine how much of your sales revenue can be put toward covering other business costs and growing your business.
How to calculate your gross margin
To determine your gross margin of sales, first calculate your costs of sales — how much it costs to produce the goods or services you sell. Include raw material purchases, manufacturing costs, and labor expenses.
Next, subtract the costs of sales from your sales revenue, and divide the number by your sales revenue. Multiply that figure by 100. This is your gross margin.
Here’s an example:
Say your sales totaled $100,000, but the cost of sales was $45,000.
$100,000 - $45,000 = $55,000.
$55,000 / $100,000 = 0.55
0.55 x 100 = 55%
That means your gross margin of sales is $55,000, or 55% of your total sales.
Why gross margin matters
Your gross margin represents the percentage of sales you can use to cover fixed costs, such as rent, utilities, insurance, and other expenses. After you cover fixed costs, you can treat any leftover money as profit to grow your business through marketing, research and development, and more.
Consider the example again.
Your gross margin was $55,000. Say your fixed costs unrelated to sales totaled $50,000. That means you would use your $55,000 in gross margin to pay for your $50,000 in fixed expenses and have $5,000 left over in net profits, equal to a net profit margin of 5%.
$55,000 - $50,000 = $5,000
While it's important your business generated $100,000 in total sales, it's also important to understand that only $5,000 could be put toward business growth after paying all expenses.
Your gross margin should be sufficient to cover fixed costs. If your fixed costs are too high, and you don't generate sufficient sales, you might not turn a profit, which could jeopardize your business. Established companies typically aim for a net profit margin that is approximately 8.5% of total sales.
Calculating the gross margin on your total sales will provide a better idea of your business's ultimate profitability and help you make wise financial decisions as you plan for future growth.
Ready to start growing your business? Here are three tips to help you grow your business organically.
"Introduction to Accounting." Slides 27 and 28. U.S. Small Business Administration (SBA). https://www.sba.gov/sites/default/files/Introduction to Accounting_Transcript_0.pdf"Understanding Gross Margin." SBA. (2016) https://www.sba.gov/blogs/understanding-gross-margin
"What is an Acceptable Net Profit Margin?" Demand Media. (2015) http://smallbusiness.chron.com/acceptable-net-profit-margin-31792.html