What is gross profit margin?
Gross profit margin is a financial metric used to measure the proportion of revenue that your business made after paying for direct expenses. It measures the profitability of a company after accounting for the cost of goods sold or services rendered.
How to calculate gross profit margin?
To calculate the gross profit margin, first, subtract ‘direct expenses’ or COGS (cost of goods sold) from ‘net sales’ which will give us the gross profit. Then, divide this gross profit by ‘total revenue’ (or sales) and multiply by 100.
Formula for calculating gross profit margin
Real-life example of gross profit margin
Let’s say your business has total revenue of $100,000 and its costs of goods sold (COGS) or cost of services are $60,000. Then, your gross profit will be $40,000 (100,000 - 60,000).
And, your gross profit margin will be: 40,000/100,000 x 100 = 40%
What’s an average gross profit margin? (benchmark)
The overall gross profit margin average sits above 30% but there is a wide disparity across various industries. Several factors play a role in the gross profit margin of a company, like the business model (product or service), industry, business model, etc.
SaaS businesses have a gross profit margin of around 60% on average. A gross profit margin of 50 to 70% would be considered healthy for product businesses.
Whereas, law firms, banks, technology businesses, and other service industry companies typically report gross profit margins in the 90% range, that’s because of the low production costs.
For in-depth info, read this report: Industry Averages for Gross Profit Margins
Ways to increase your gross profit margin
- Consider increasing prices: This is the most direct way to increase your gross profit margin. By charging more for your products or services, you can generate more revenue per sale and therefore increase your gross profit margin. However, be careful not to raise your prices too much, as this can lead to a decrease in demand for your products and hurt your overall sales.
- Try to reduce costs: This is yet another direct way to increase your gross profit margin. By reducing your costs, you can increase the amount of money you make on each sale and therefore increase your gross profit margin. For example, you could implement modern processes and automate some elements.
- Expand into new markets: Expanding into new markets can also help you increase your gross profit margin, like, entering new geographic regions or targeting new customer segments. By expanding, you can increase your customer base and generate more revenue, which can help you increase your gross profit margin.