Gross profit margin: What it is, how to calculate it, and how to improve it

What is gross profit margin?

Key takeaways:

• Gross profit margin is a profitability ratio that shows the percentage of revenue a business retains after covering its cost of sales (COS).

• In a business context, the gross profit margin answers a fundamental question of how efficiently a business turns revenue into gross profit.  

• A higher margin generally indicates stronger pricing power, better cost control, or both. A declining margin can signal rising input costs, discounting, inefficiencies, or competitive pressure.

Gross profit margin vs Gross profit

Gross profit and gross profit margin are closely related, but they tell very different stories. The key difference lies in comparability. Gross profit can increase simply because sales volumes grow, even if efficiency worsens. Gross profit margin shows whether the business is becoming more or less profitable per dollar of revenue.  

Gross profit is an absolute figure. It represents the total amount left after subtracting COS from revenue. The formula for this is: Gross profit = Revenue − Cost of sales

Gross profit margin, on the other hand, expresses gross profit as a percentage of revenue. It shows proportional profitability rather than total dollars earned.

How to calculate gross profit margin

The standard gross profit margin formula is:

Gross profit margin = Gross profit / Revenue x 100

Each component matters:

• Gross profit represents the revenue remaining after deducting all costs directly related to generating sales. It reflects how much is available to cover operating expenses and contribute to overall profit.

• Revenue includes income generated from core trading activities, such as product sales or service fees, net of returns and discounts.

Importantly, operating expenses such as rent, marketing, administrative salaries, and software subscriptions do not belong in COS. Including them will distort the margin and undermine its usefulness.

Step-by-step gross profit margin calculation

Here’s a simple walkthrough of how to calculate gross profit margin:

1. Start with total revenue for the period.
2. Subtract the cost of sales sold to calculate gross profit.
3. Divide gross profit by total revenue.
4. Multiply the result by 100 to express it as a percentage.

Gross profit margin example calculation

Gross profit margin formula = Gross profit / Revenue x 100

Imagine a wholesale business with the following figures for a quarter:

• Revenue: $250,000
• Cost of sales: $150,000

First, calculate gross profit: $250,000 − $150,000 = $100,000

Next, calculate gross profit margin: $100,000 / $250,000 x 100 = 40%

This means the business retains 40 cents in gross profit for every dollar of revenue generated, before operating expenses are deducted.

Common gross profit margin calculation mistakes

Even experienced teams can make errors when calculating gross profit margin. The most common mistakes include:

• Incorrect cost of sales classification: Including indirect costs or excluding legitimate direct costs skews results.

• Including operating expenses: This turns gross margin into something closer to operating margin, reducing clarity.

• Inconsistent periods: Comparing revenue from one period with the cost of sales from another period can lead to misleading conclusions.

Clear cost definitions and consistent reporting periods are essential for reliable margin analysis.

Analysing gross profit margin for business insights

Gross profit margin is a diagnostic tool that can highlight pricing issues, cost pressures, and operational inefficiencies long before they appear in net profit figures. Tracking margin alongside related KPIs such as gross profit growth helps finance teams detect underlying performance shifts early. Tools like financial analysis software can improve this process by providing real-time insights, visual trend analysis, and deeper drill‑downs into cost drivers.

Plus, using a dedicated KPI tracking software can significantly improve this analysis. Intuitive dashboards can allow you to monitor gross profit margin trends in real time, compare performance across periods, and look into drivers without relying on static spreadsheets.

Interpreting gross profit margin trends

A single gross profit margin figure offers limited insight on its own. Trends over time are far more valuable.

An improving margin suggests stronger pricing, better supplier terms, or improved efficiency. A declining margin may point to rising input costs, increased discounting, or operational challenges.

Sudden changes often warrant immediate investigation, while gradual shifts may indicate structural changes in the business model.

Factors affecting gross profit margin

Several internal and external factors influence gross profit margin:

• Pricing decisions: Discounts, promotions, and price increases directly affect revenue per unit.

• Input costs: Changes in raw material prices, direct labour rates, or freight and delivery costs flow straight into the cost of sales, affecting gross profit margin.

• Supplier changes: New suppliers or renegotiated contracts can improve or weaken margins.

• Operational efficiency: Waste, rework, and poor capacity utilisation all erode gross profit.

Understanding which factors drive margin movements is critical to take effective corrective action.

What is a good gross profit margin?

There is no single “good” gross profit margin that applies to all businesses. What’s considered healthy varies widely by industry, business model, and competitive environment.

Gross profit margin benchmarks by industry

At a high level, industry benchmarks help contextualise whether a business’s gross profit margin is strong, average, or underperforming. Here are some varying examples:  

• Retail and wholesale businesses often operate on margins between 20% and 40%, as seen in broad industry comparisons provided by FullRatio.

• Manufacturing margins generally fall between 30% and 50%, depending on scale and automation, with sector-level ratios detailed in the ReadyRatios Gross Margin by Industry tables.

• Professional services and software businesses typically achieve significantly higher margins, often 60% to 80% or more, supported by SaaS industry benchmark reports from CloudZero and quarterly profitability insights from CSIMarket’s Software & Programming Industry Reports.

• Retail and wholesale businesses often operate on margins between 20% and 40%.

• Manufacturing margins typically range from 30% to 50%, depending on scale and automation.

• Professional services and software businesses can achieve margins of 60% to 80% or higher, due to lower direct costs.

These ranges are indicative rather than definitive. The most meaningful benchmark is often a business’s own historical performance and that of close competitors.

When to reassess your gross profit margin

It’s wise to reassess gross profit margin whenever there are material changes in the business, including:

• Significant cost increases from suppliers or labour markets: Shifts in commodity prices, wage pressures, or changes to supplier agreements can materially alter your cost structure. Even modest increases can compound quickly, particularly for product‑based businesses where COS is a major proportion of total expenses.

• Pricing changes, whether driven by strategy or competition: When prices are adjusted, either upward to reflect increased value or downward in response to market pressure, your gross profit margin will inevitably shift. Regular review helps ensure that pricing decisions are delivering the intended commercial outcome rather than unintentionally eroding profitability.

• Expansion into new markets, products, or service offerings: Entering a new region, launching a new product line, or adding a service offering often changes the cost base and revenue mix. Different products carry different margins, and without monitoring, a rapidly growing but low‑margin offering may dilute overall profitability.

Beyond these specific triggers, businesses should also reassess gross profit margin during planning cycles, budgeting rounds, and after major operational changes such as process improvements, supplier renegotiations, or shifts in production capacity.

Regular reviews and accurate financial statement reporting are important practices for you to make decisions and drive improvements based on reliable data.

Gross profit margin compared with other metrics

Gross profit margin is powerful, but it doesn’t tell the whole profitability story on its own.  

Gross profit margin vs Operating profit margin

Operating profit margin goes a step further by factoring in operating expenses such as rent, marketing, and administration. While gross margin focuses on production efficiency, operating margin reflects overall cost control and scale efficiency.

A strong gross margin with a weak operating margin may indicate high overheads or inefficient operations.

Gross profit margin vs Net profit margin

Net profit margin includes all expenses, taxes, and interest. It shows how much profit ultimately remains for shareholders.

This is why gross margin alone isn’t enough. A business can have an excellent gross margin but still struggle if operating costs or financing expenses are too high.

How to use these metrics together

Using these margins together creates a layered profitability analysis. Gross margin highlights core trading efficiency, operating margin assesses cost structure, and net margin shows overall financial health.

For accountants, this layered view supports clearer insights and more effective advisory conversations.

How to improve gross profit margin

Improving gross profit margin typically requires a combination of pricing discipline, cost management, and operational improvements.  

Adjust pricing strategically

Pricing is one of the fastest levers for improving margin, but it must be handled carefully. Even small price adjustments can have a disproportionate impact on gross profit.

• Pricing discipline ensures discounts are intentional and aligned with strategy.
• Value-based pricing focuses on what customers are willing to pay, rather than simply adding a markup to costs.

Reduce the cost of sales

Lowering the cost of sales directly increases gross margin without changing revenue. Regular supplier reviews and cost analysis are essential here.

• Supplier renegotiation can secure better pricing or terms.
• Cost control measures reduce waste, spoilage, and inefficiencies in production or delivery.

Improve operational efficiency

Operational improvements often deliver sustainable margin gains. Over time, these efficiencies compound to strengthen profitability.

• Waste reduction minimises lost materials and time.
• Better planning and forecasting improve inventory, staffing, and capacity utilisation. For service‑based businesses, this includes more accurate scheduling, project scoping, and resource allocation.

For deeper interpretation and stronger margin‑improvement opportunities, you can refer to this comprehensive financial profitability analysis guide.

Final thoughts

Gross profit margin remains one of the most fundamental indicators of a business’s financial health. It not only reflects how efficiently a company produces and sells its goods or services but also acts as an early warning system for pricing pressure, rising costs, or operational challenges.  

While the right gross profit margin varies by industry and business model, consistent monitoring and thoughtful analysis are key. Understanding the drivers of margin performance can help you gain more strategic decision-making, whether that involves refining pricing strategies, negotiating better supplier terms, or improving internal processes.