What is gross margin?
Gross Margin · Also called gross margin %, gross profit margin, GM, gross profit
Gross margin is gross profit divided by net revenue, where gross profit is net revenue minus COGS. It shows how much of each revenue dollar is left after product costs.
What it is
Use your own revenue: what you invoice your customer, which is the distributor or the retailer, not the shopper. The retailer's shelf price is not your revenue when you sell wholesale, and the retailer and distributor margins are already reflected in your invoice price, so do not take them off again. Net revenue is also not the same as the cash in your bank.
Margin divides profit by the selling price; markup divides it by cost. A product that costs you $1.35 and earns you $2.70 has a 50% gross margin but a 100% markup.
Vaaha Unit Economics uses your invoice price as net revenue and takes trade spend off below gross profit. Accountants often deduct some trade spend from revenue instead, for example $0.30 a unit, giving $2.40 net revenue and a 43.75% gross margin. Either way, count trade spend once: never subtract it from revenue and again below gross profit.
Why it matters
Gross profit has to pay for everything not already in COGS or netted from revenue: trade spend, broker commissions, marketing, fulfillment and overhead. If gross margin is thin, there is little room for the support it takes to grow at retail.
Investors and buyers look at gross margin early because it is slow to fix. Improving it usually means a better price, cheaper inputs or larger runs, all of which take time. Look at it per SKU and per channel, not only as one blended number.
Formula
Gross margin % = (Net revenue − COGS) ÷ Net revenue
Markup % = (Net revenue − COGS) ÷ COGS. If net revenue is zero, the percentage is undefined; show the dollar amounts instead.
Worked example
Gross margin on a $6.00 SRP product
- Assume you invoice $2.70 per unit after the retailer and distributor margins, and landed COGS is $1.35 per unit.
- Gross profit = $2.70 − $1.35 = $1.35.
- Gross margin = $1.35 ÷ $2.70 = 50%. Markup on cost = $1.35 ÷ $1.35 = 100%.
- If your accountant records $0.30 a unit of trade allowances as a reduction of revenue, net revenue is $2.70 − $0.30 = $2.40, gross profit is $2.40 − $1.35 = $1.05, and gross margin is $1.05 ÷ $2.40 = 43.75%. The $0.30 then does not come off again below gross profit.
- Figured wrongly on the $6.00 SRP, it would look like ($6.00 − $1.35) ÷ $6.00 = 77.5%, which is not money you receive.
Common mistakes
- Calculating gross margin on SRP or on the retailer's buying price instead of your own net revenue.
- Quoting markup when someone asks for margin. A 100% markup is only a 50% margin.
- Deducting trade allowances from revenue and then subtracting them again below gross profit.
- Using a COGS that leaves out freight, normal yield loss or packaging, which inflates the margin.
Common questions
- Can I have a good gross margin and still lose money?
- Yes. Trade spend, commissions, fulfillment, marketing and fixed overhead can add up to more than your gross profit. Contribution margin and operating profit answer those questions.
- What is a good gross margin for a CPG brand?
- There is no single threshold that makes every brand healthy. Your category, route to market, production scale and the costs below gross profit all decide what is enough, so work it through to contribution.