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Understanding the basics of GM: How to calculate Gross Margin for a small business

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As a small business owner or a new entrepreneur, you must have heard the term GM or Gross Margin thrown around a lot. But what does it exactly mean and why is it important for your business? Gross Margin is a crucial concept to understand as it helps you determine your product pricing, identify profit margins, and make informed decisions about your business investments. In this blog post, we will dive deep into the basics of GM and learn how to calculate it effectively.

What is GM?

Gross Margin or GM is the difference between your revenue and the cost of goods sold (COGS). It indicates the amount of money you have left over after taking out the expenses associated with producing and selling a product. The GM is usually expressed as a percentage and is a crucial metric to consider while calculating your profit margins. By knowing your GM, you can adjust your pricing strategy to increase your profits and improve your business performance.

How to Calculate GM?

GM is calculated by subtracting the COGS* from the revenue earned from the sale of a product and dividing it by the total revenue. The formula for calculating GM is as follows:

Gross Margin = (Revenue - COGS) / Revenue * 100

For example, if your business earns $50,000 in revenue and has $30,000 in COGS, then your GM would be ($50,000 - $30,000) / $50,000 * 100 = 40%.

With examples in the workbook you will:
Learn the difference between gross margin and markup based prices.
👉 Notice the impact of a small increase to margin has a huge positive impact to bottom line but the increase to the selling price is that significant
👉Realize that giving a discount has a significant impact to the profitability

Why is GM Important?

GM is an essential tool that helps you to determine the profitability of your business. By tracking your GM, you can identify which products are profitable and which ones are not. It also helps you adjust your pricing strategy to achieve higher profit margins and boost revenue growth. Moreover, GM data helps you to make better business decisions and plan for future investments. By keeping a close eye on your GM, you can avoid making financial mistakes and ensure a healthy cash flow in your business.

What is a "good" gross margin?

A good gross margin is one that allows you to cover your costs, pay your employees, and still generate a healthy profit. A general rule of thumb is that a gross margin of at least 50% is good, but this can vary greatly depending on your industry and unique business model. Ultimately, it's important to consistently monitor and adjust your margins to ensure the financial stability and growth of your business.

Factors Affecting GM

Many factors can impact your GM, such as changes in the cost of raw materials, fluctuating demand, and competition in the market. Therefore, it's crucial to monitor your GM regularly to identify potential issues and adjust your pricing strategy accordingly. Adopting a proactive approach towards GM management can help you to maximize your profits and achieve long-term business success.

Tips for Improving GM

Calculating and monitoring your GM is only the first step towards improving your business profitability. To achieve higher GM, you need to focus on reducing your COGS and increasing your revenue. Some effective strategies to consider include negotiating better deals with your suppliers, optimizing your inventory management, and introducing new products that have higher profit margins. By investing in these areas, you can gradually increase your GM and grow your business over time.

In conclusion, Gross Margin or GM is a crucial metric to consider while running a small business or starting a new venture. By calculating and monitoring your GM, you can identify potential issues, adjust your pricing strategy, and make informed decisions about investments. It's essential to remember that improving your GM is a continuous process that requires consistent efforts and attention to detail. By applying the necessary strategies and best practices, you can achieve higher profits, improved cash flow, and long-term business success.

Additional information:

*What is Cogs? COGS stands for Cost of Goods Sold. It is a financial metric that represents the direct costs associated with producing goods sold by a company. This includes both direct labor costs used to produce the good and the cost of raw materials used in production.

  • In accounting, COGS is deducted from revenues (sales) in order to calculate gross profit and gross margin. It's an important figure for businesses because it directly impacts profitability. If COGS increases, it reduces the company's gross profit margin, making the business less profitable.

    Here's the formula for COGS:

    COGS = Opening Inventory + Purchases During the Period - Closing Inventory

    • Opening Inventory: The value of goods available for sale at the beginning of the accounting period.
    • Purchases During the Period: The cost of goods purchased to be sold during the accounting period.
    • Closing Inventory: The value of unsold goods at the end of the accounting period.

    It's worth noting that not all companies have a COGS figure. Service companies, for example, typically don't have a COGS because they don't sell physical goods. Instead, they might have cost of services or cost of sales.

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