To be able to calculate gross margin, you need to what gross margin is:
Gross margin is the amount of revenue you have after deducting the cost of goods you sold. It is usually expressed as a ratio of aggregate revenue. You can use gross margin for operating expenses and reinvest back into the business to grow it further.
If you own a startup, it is mandatory to keep track of your gross margin. It can derive the growth chances of your business. If the gross margin is high, you are more likely to grow your business rapidly as you will have more money to reinvest and spend on the growth of your startup.
In today’s blog, we will cover details about the Gross Margin. Calculating gross margin, knowing a good gross margin, tips to improve it, and numerous other things will be discussed.
To calculate it, you first need to know the cost of goods sold or simply COGS. It not only contains the amount you need to buy goods, but other expenses as well that are necessary to provide your products or services to customers. Hosting, Marketing, 3rd Party integration fees, Support cost, etc. are also included in COGS.
Once you have the monthly COGS value, it will be easy to calculate the gross margin. Dividing the subtraction product of COGS and MRR by revenue will give you the gross margin.
Gross Margin Formula
Gross Margin % = Revenue-COGS ÷ Revenue = Gross Profit÷Revenue×100
Example: You sold a pen for $20. The average cost to make, market, pack, and ship this pen is around $5. So the gross margin will be 75%.
Gross margin= (20 – 5) ÷ 20 = 75%.
Are gross margin and net margin different? If yes, then how?
Yes! Both these metrics are different.
Gross margin is the revenue you have after subtracting the COGS from the amount you earned after selling products. On the other hand, net margin is the revenue left over after all types of expenses. Even the taxes and operating expenses are deducted.
Net margin is considered a more comprehensive measure of profitability as all types of expenses, even minor ones are excluded from it. While in gross margin only COGS is excluded.
What can you say is a good gross margin for your SaaS company?
It’s simple maths that if you want to earn profits, you need to sell your products at a cost higher than the total expenses of goods. The more money you make by selling a product, the better it will be for your business or organization.
You want to grow the gross margin with the growth of your firm. A better gross margin means every single dollar is more valuable for your business.
Let’s compare two companies, one with a 10% gross margin and the other with a 70% gross margin. The first one will have Only 10 cents per dollar to reinvest in the company. While the company with a 70%/gross margin is able to reinvest 70 cents per dollar and has better growth chances.
This may be the reason why a company worth $10 million is better than the one having $20 million in revenues. The first one will definitely have a better gross margin.
What are some benchmarks for SaaS gross margin?
According to data analysis and research, SaaS companies have a median gross margin of around 73%. However, it may vary from company to company based on the nature of the business and other factors.
Example: SaaS enterprise companies tend to have more gross margins as compared to nonenterprise SaaS companies.
SaaS experts suggest that as an owner of a SaaS company, your aim must be a gross margin of 80%.
As a SaaS company owner, you have only two effective methods to elevate gross margin. These are:
- Elevating revenues
- Minimizing COGS
When you just start as a SaaS company owner, the gross margin will be lower as you are not fetching benefits from economies of scale. As you spend some time in the market, you start growing and acquiring new customers. It becomes easy and affordable for you to support each one. As a result, COGS start decreasing which will ultimately elevate your gross margin.
Continuously reducing pricing, increasing revenues, and elevating gross margins can be tempting or inviting for you. However, you need to maintain a balance. Bad quality to reduce COGS and extremely higher prices may lead you to acquire fewer customers. A 50% gross margin on $1500 revenue is far better than a 90% gross margin on $50 revenue. Therefore, you must focus on acquiring more customers as well.