Understanding Gross Margin: Why It’s the Metric Most Business Owners Miss
If you’re a small business owner, you’ve likely looked at your Profit & Loss statement and jumped straight to the bottom line: net income. After all, that’s the number that tells you if you’re making money, right?
But there’s a key metric sitting above the fold that could tell you much more about the financial health of your business—and it often gets overlooked: gross margin.
In this post, we’ll break down what gross margin is, why it matters more than you think, how to calculate it, and—most importantly—how to use it to run a smarter, more profitable company.
Whether you’re running a professional services firm, a trades business, or a small e-commerce company, understanding your gross margin is one of the most important financial habits you can develop.
What Is Gross Margin?
Gross margin is a profitability metric that shows how much money you keep from every dollar of sales after covering the direct costs to produce your goods or deliver your services.
The formula is:
Gross Margin (%) = (Revenue – Cost of Goods Sold) / Revenue × 100
Cost of Goods Sold (COGS) includes only the direct costs tied to what you're selling. That could be:
Materials and labor for a contractor
Inventory for a retailer
Subcontractors or service delivery staff for an agency
It does not include overhead like rent, office salaries, or marketing—that’s captured further down in your Profit & Loss (P&L) statement.
Why Gross Margin Gets Overlooked
Most business owners are busy. They’re hustling to grow sales, pay the bills, and make payroll. Many rely on their bank account balance to gauge success. Others glance at revenue and net profit and assume everything in the middle is “just accounting.”
But that middle section—your gross margin—is where your real business model lives.
Ignoring gross margin leads to all kinds of problems, including:
Pricing that doesn’t actually cover costs
Hidden inefficiencies in delivery
Rapid growth that destroys profitability
Misleading assumptions about scalability
Think of gross margin as your first line of defense in financial management. If it’s too low, nothing you do further down the P&L will matter.
Gross Margin vs. Net Profit: What’s the Difference?
Let’s clarify the difference between gross margin and net profit, because they serve different purposes.
Gross margin tells you how profitable your product or service is before overhead costs. It only includes direct costs tied to delivering that product or service.
Net profit tells you how much money is left after covering all expenses—salaries, rent, software, marketing, taxes, and more.
Gross margin answers the question: "Are we pricing our product or service high enough to cover direct costs and still have money left over?"
Net profit answers: "After paying for everything else, are we making money overall?"
Both matter, but gross margin is your first red flag if something’s off.
How to Calculate Gross Margin in QuickBooks
If you’re using QuickBooks Online (or a similar accounting tool), calculating your gross margin is simple.
Run a Profit & Loss report for the period you want to analyze (monthly, quarterly, yearly).
Look at Total Income (revenue), Cost of Goods Sold, and Gross Profit.
Use the formula: Gross Margin (%) = (Gross Profit ÷ Revenue) × 100
Tip: Customize your P&L to add a gross margin percentage column so you can track it over time.
5 Reasons Gross Margin Should Be Your Favorite Metric
1. It Helps You Price Better
Most small businesses underprice their products or services. If your margin is too thin, even a small mistake can wipe out your profit. Use your gross margin to work backwards. For example, if your cost to deliver is $4,000 and you want a 60% gross margin, your price needs to be at least $10,000.
2. It Tells You If Growth Is Actually Profitable
You might be growing your sales, but if your gross margin is shrinking, you're working harder for less. That’s not sustainable. Growth is only good if it's profitable growth.
3. It Highlights Operational Inefficiencies
A declining gross margin can point to problems like rising supplier costs, delivery inefficiencies, or wasted materials. Tracking this metric helps you identify and fix problems before they eat into your bottom line.
4. It Helps You Forecast Accurately
Gross margin is a key component of budgeting and forecasting. If you know your margin and revenue projections, you can better estimate how much money you’ll have left to cover overhead and generate profit.
5. It’s What Investors and Buyers Care About
If you plan to raise capital or sell your business one day, gross margin will be a focal point. High gross margins signal scalability. Low margins mean you’ll need high volume to stay afloat, which investors see as riskier.
Common Mistakes Business Owners Make
Lumping Too Many Costs Into COGS
Be careful not to put overhead expenses into your Cost of Goods Sold. That can make your gross margin look worse than it is and give you false data.
Not Reviewing Gross Margin Monthly
Your margin can change monthly based on seasonality, vendor pricing, and labor. Track it regularly to catch changes early.
Relying Only on Bank Balances
What’s in your bank doesn’t tell you if your sales are profitable. Financial reports and margin analysis give you the clarity you need.
How to Improve Your Gross Margin
Raise Prices
This is often the quickest way to improve gross margin. Even small increases—5 to 10 percent—can have a big impact, especially if your direct costs stay the same.
Reduce Direct Costs
Negotiate with vendors, improve job efficiency, or streamline your supply chain.
Redefine Your Offer
Focus on selling your highest-margin products or services. Eliminate or reprice low-margin offerings.
Track Project or Job-Level Margins
Use tools like QuickBooks Projects to analyze margins by client, job, or product. This gives you visibility into what’s actually driving profit.
Final Thoughts: Make Gross Margin Your Financial North Star
If you take away one thing from this blog, let it be this:
Revenue is vanity. Net profit is reality. Gross margin is strategy.
Gross margin tells you how well your business model works. It shows whether your pricing is sound, your delivery is efficient, and your growth is actually adding value.
At Axis Outsourced Accounting, we help business owners get clear on their numbers—starting with the ones that matter most. If you’re ready to take control of your profitability, we’d love to talk.