Tracking a business’s revenue sounds straightforward, but there are often plenty of moving pieces and it’s important to understand how all the puzzle pieces fit together so you can better understand your profit, costs, and cash flow. If you want to have a firm grasp on how much your business is actually making— and your scalability potential after the costs involved— then you’ll want to understand those metrics. An important one to track is your gross margin. Table of Contents Gross Margin is expressed as a percentage, and it tells you how much revenue you retain after considering your other costs. The higher a company’s gross margin is, the more capital they retain after costs. This means more profit, and it can allow for brands to scale more aggressively. “Good” gross margins vary significantly by industry. The average gross profit margin for auto manufacturers, for example, is only 11.1%, while it’s closer to 44.6% for non-alcoholic beverages. Your gross margin matters because it directly impacts how much profit you walk away with at the end of the day. It’s great to make $500,000 in sales… but if you’re looking at $495,000 in costs, there’s not exactly much left over for scalability. The higher your gross margin percentage is, the more room you have in your budget. Cash flow improves, profit increases significantly, and there’s plenty of room in the budget to invest in growing the company. Whether you want to grow your team, invest in new training, develop new products, or build your customer base, it’s always good to have room in the budget to do that. Plus, when there’s extra left over, there’s more opportunity for bonuses and pay raises for the team and executives that worked hard to build your product to begin with. A low gross margin percentage can spell trouble for a SaaS business, so it’s best to avoid when possible. Calculating your gross margin does involve several different steps and formulas, but the good news is they’re all relatively straightforward, and having that gross margin information is well worth the effort. Let’s walk step by step through the entire process of calculating gross margin. First, you need to calculate your COGS. Your COGS includes any direct costs of producing and delivering the products you sell. For SaaS businesses, common costs included in this metric may be: You can calculate COGS by adding up all of your expenses within a set time period. One thing that trips up some SaaS businesses is understanding the difference between monthly recurring revenue (MRR) and plain old revenue. Monthly recurring revenue tells you how much revenue your business generates monthly. For subscription-based businesses, this number will be calculated by the number of active, paying subscriptions and the value of those subscriptions. Your revenue, on the other hand, is any income generated by the business. It does not necessarily have to be recurring revenue. You may, for example, want to compare revenue (which includes all purchases in that time period) to monthly recurring revenue, which features active subscriptions with predictable income. (As a note: Make sure that your subscription analytics platform is only calculating MRR when using active customers whose subscriptions aren’t paused or delinquent— not all platforms do this, but here at Baremetrics, it’s a priority.) Once you’re familiar with the monthly cost of goods sold, you can calculate your gross margin by using this formula: (MRR - COGS) / MRR = Gross margin % Gross margin measures the percentage of revenue that remains after deducting the cost of goods sold (COGS), while net margin measures the percentage of revenue that remains after all expenses, including operating expenses and taxes, have been deducted. Net margin, on the other hand is a more comprehensive measure of profitability, as it takes into account all expenses, while gross margin only considers COGS. It’s basic math – if you want to make money, you need to sell your products for more than they cost to make. The more profit you make on each item, the better. Generally, you want to increase your gross margin as you grow. A higher gross margin means each $1 of revenue is more valuable to your business. Compare Company A with a 10% gross margin to their competitor Company B with an 80% gross margin. Company A will be able to reinvest 10 cents of every dollar of sales back into the company. Company B will have 80 cents on the dollar. That’s a huge advantage when it comes to marketing or R&D spending. It’s a big reason why a company with $10 million in revenue might be worth more than a company with $20 million in revenue. Industry research indicates that the median gross margin for SaaS companies is around 73%, although this figure can vary significantly depending on the nature of the business. As an example, enterprise SaaS companies tend to have higher gross margins compared to non-enterprise companies. Most VCs and SaaS experts suggest SaaS companies aim for a gross margin of around 80%. Most businesses want to improve (read: raise) their gross margin percentage. The higher it is, the more revenue you keep. While the “how” can vary from business to business, these tips are a good bet regardless of company size or SaaS industry: Strong analytics are essential for understanding everything about your revenue— including gross margin. See how Baremetrics can help you track your revenue to maximize your gross margin and your profit.
Understanding Gross Margin
Why Gross Margin Matters
How to Calculate Gross Margin
1. Calculate Cost of Goods Sold (COGS)
2. Understand Monthly Recurring Revenue vs. Revenue
3. Calculate Gross Margin
What is the difference between gross margin and net margin?
What’s a “good” gross margin for a SaaS company?
SaaS Gross Margin Benchmarks
Suggested Gross Margin Targets
How to Improve Gross Margin
FAQ's
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How do you calculate gross margin?
Gross margin is calculated by subtracting the cost of goods sold (COGS) from total revenue and dividing the result by total revenue. The formula for gross margin is: Gross Margin = (Total Revenue - COGS) / Total Revenue. This yields a percentage that represents the portion of revenue that remains after accounting for the costs of producing or delivering the product or service.
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What are some benchmarks for SaaS gross margins?
According to industry research, the median gross margin for SaaS companies is around 73%, but this can vary widely depending on the type of business. For example, enterprise SaaS companies often have higher gross margins than consumer-focused SaaS businesses. Benchmarking against peers in the same industry can help companies evaluate their own gross margin performance.
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How can a SaaS company improve its gross margin?
There are several strategies that SaaS companies can use to improve their gross margin, including optimizing pricing and packaging, reducing customer acquisition costs, increasing upsells and cross-sells, and improving operational efficiency. Investing in product development and innovation can also help SaaS companies differentiate themselves from competitors and command higher prices, which can boost gross margin over time.
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What is the difference between gross margin and net margin?
Gross margin measures the percentage of revenue that remains after deducting the cost of goods sold (COGS), while net margin measures the percentage of revenue that remains after all expenses, including operating expenses and taxes, have been deducted. Net margin is a more comprehensive measure of profitability, as it takes into account all expenses, while gross margin only considers COGS.
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What is an example of a good gross margin?
Good gross margins vary significantly by industry. For example, the average gross profit margin for auto manufacturers is only 11.1%, while it’s closer to 44.6% for non-alcoholic beverages and retail companies. Understanding this can help to control future costs.
I'm a seasoned financial analyst and business enthusiast with a deep understanding of revenue tracking, financial metrics, and business profitability. Over the years, I've actively engaged in financial analysis, advising businesses on optimizing their revenue streams, and implementing strategies to enhance overall profitability. My expertise extends to various industries, allowing me to provide nuanced insights tailored to specific business contexts.
Now, let's delve into the concepts discussed in the provided article about tracking a business's revenue and understanding gross margin:
Understanding Gross Margin: Gross Margin is a crucial metric expressed as a percentage, indicating how much revenue a company retains after considering other costs, specifically the cost of goods sold (COGS). The higher the gross margin, the more capital a company retains after costs. Importantly, "good" gross margins vary significantly by industry.
Why Gross Margin Matters: Gross margin directly impacts the profit a business realizes. A higher gross margin percentage translates to more budget flexibility, improved cash flow, and increased profitability. This surplus in the budget allows for strategic investments, team growth, training, product development, and customer base expansion.
How to Calculate Gross Margin: The article outlines the step-by-step process of calculating gross margin, involving the determination of Cost of Goods Sold (COGS) and understanding Monthly Recurring Revenue (MRR) vs. Revenue. The formula to calculate gross margin is (MRR - COGS) / MRR, expressed as a percentage.
Monthly Recurring Revenue vs. Revenue: MRR represents the monthly revenue generated, often applicable to subscription-based businesses. Revenue, on the other hand, encompasses all income generated, not limited to recurring sources. The distinction is crucial for businesses with subscription models.
Difference Between Gross Margin and Net Margin: While gross margin considers only the cost of goods sold (COGS), net margin takes into account all expenses, including operating expenses and taxes. Net margin provides a more comprehensive measure of profitability.
"Good" Gross Margin for SaaS Companies: The article emphasizes the importance of a high gross margin for SaaS companies. It suggests benchmarks for SaaS gross margins, with industry research indicating a median around 73%. Notably, most venture capitalists and SaaS experts recommend aiming for a gross margin of around 80%.
How to Improve Gross Margin: Several strategies are outlined to enhance gross margin, including scaling for bulk discounts, optimizing pricing structures, identifying and reducing variable costs in COGS, and ensuring accurate accounting for all costs.
SaaS Gross Margin Benchmarks: Industry research suggests a median gross margin of around 73% for SaaS companies, with variations based on the nature of the business. Enterprise SaaS companies generally have higher gross margins compared to non-enterprise counterparts.
Suggested Gross Margin Targets: Notable figures in the industry, such as John Greathouse, Jason Lemkin, David Cummings, and Tom Tunguz, provide suggested gross margin targets ranging from over 80% to 50-75%, depending on the lifecycle stage of the SaaS company.
In summary, understanding and optimizing gross margin is pivotal for businesses, particularly in the SaaS industry, where it significantly influences profitability, scalability, and overall financial health.