Short Definition
Gross Margin (%) measures the percentage of revenue left after direct costs (Cost of Sales) to make and deliver the product or service. It’s a core profitability metric and signals the scalability and quality of revenue.
Short Definition
Gross Margin (%) measures the percentage of revenue left after direct costs (Cost of Sales) to make and deliver the product or service. It’s a core profitability metric and signals the scalability and quality of revenue.
Short Definition
Gross Margin (%) measures the percentage of revenue left after direct costs (Cost of Sales) to make and deliver the product or service. It’s a core profitability metric and signals the scalability and quality of revenue.
Why it matters for Investors
Quality & pricing power: Higher margins signal durable economics and room to invest in growth.
Foundation for efficiency math: CAC Payback, Rule of 40, FCF, and profitability all depend on gross margin.
Comparability across models: Normalizes different pricing/COGS structures for apples-to-apples benchmarking.
Why it matters for Investors
Quality & pricing power: Higher margins signal durable economics and room to invest in growth.
Foundation for efficiency math: CAC Payback, Rule of 40, FCF, and profitability all depend on gross margin.
Comparability across models: Normalizes different pricing/COGS structures for apples-to-apples benchmarking.
Why it matters for Investors
Quality & pricing power: Higher margins signal durable economics and room to invest in growth.
Foundation for efficiency math: CAC Payback, Rule of 40, FCF, and profitability all depend on gross margin.
Comparability across models: Normalizes different pricing/COGS structures for apples-to-apples benchmarking.
Formula
Practical considerations -
Cost of Sales policy (be explicit): Define what sits in COGS/Cost of Sales vs OpEx (S&M, R&D, G&A). Apply consistently period to period.
Delivery-linked costs (people + infra): If implementation/support is required to meet contracted SLAs, include those labor costs in COGS; general/reactive support goes to OpEx. Include hosting/CDN, third-party APIs/LLM tokens, and payment processing that scale with delivery in COGS.
Fintech/marketplaces: Include processing fees, chargebacks and (policy-dependent) fraud losses, plus partner take-rates.
PS/hardware pass-throughs: If you recognize that revenue gross, include the matching delivery costs in COGS; otherwise present Net Revenue for clarity.
One-offs: Reclassify unusual items out of COGS (or flag separately) to avoid “managing” margin.
Multi-product: Track margin by product/SKU/plan/channel—blended margins can hide leakage.
Formula
Practical considerations -
Cost of Sales policy (be explicit): Define what sits in COGS/Cost of Sales vs OpEx (S&M, R&D, G&A). Apply consistently period to period.
Delivery-linked costs (people + infra): If implementation/support is required to meet contracted SLAs, include those labor costs in COGS; general/reactive support goes to OpEx. Include hosting/CDN, third-party APIs/LLM tokens, and payment processing that scale with delivery in COGS.
Fintech/marketplaces: Include processing fees, chargebacks and (policy-dependent) fraud losses, plus partner take-rates.
PS/hardware pass-throughs: If you recognize that revenue gross, include the matching delivery costs in COGS; otherwise present Net Revenue for clarity.
One-offs: Reclassify unusual items out of COGS (or flag separately) to avoid “managing” margin.
Multi-product: Track margin by product/SKU/plan/channel—blended margins can hide leakage.
Formula
Practical considerations -
Cost of Sales policy (be explicit): Define what sits in COGS/Cost of Sales vs OpEx (S&M, R&D, G&A). Apply consistently period to period.
Delivery-linked costs (people + infra): If implementation/support is required to meet contracted SLAs, include those labor costs in COGS; general/reactive support goes to OpEx. Include hosting/CDN, third-party APIs/LLM tokens, and payment processing that scale with delivery in COGS.
Fintech/marketplaces: Include processing fees, chargebacks and (policy-dependent) fraud losses, plus partner take-rates.
PS/hardware pass-throughs: If you recognize that revenue gross, include the matching delivery costs in COGS; otherwise present Net Revenue for clarity.
One-offs: Reclassify unusual items out of COGS (or flag separately) to avoid “managing” margin.
Multi-product: Track margin by product/SKU/plan/channel—blended margins can hide leakage.
Worked Example
Line item | Amount | Notes |
|---|---|---|
Revenue | $50,000,000 | Per policy (GAAP or non-GAAP; match with COGS) |
Inventory/ Bill of Materials + Inbound Freight | $18,500,000 | Product cost |
Warehousing/ Packaging/ Returns | $3,000,000 | Fulfilment & reverse logistics |
Third-party APIs/ Processing | $1,000,000 | Payments/data/API tied to delivery |
Total COGS | $22,500,000 | |
Gross Profit | $27,500,000 | Revenue - COGS |
Gross Margin (%) | 55% | (27.5 ÷ 50.0) × 100 |
Notes
Don’t mix bases: If revenue is non-GAAP, COGS must be non-GAAP (with reconciliation).
Pass-throughs: If you gross up revenue for pass-through items, include matching costs in COGS (or report net).
Multi-product: Track margin by SKU/plan/channel; blended margins can hide leakage.
Worked Example
Line item | Amount | Notes |
|---|---|---|
Revenue | $50,000,000 | Per policy (GAAP or non-GAAP; match with COGS) |
Inventory/ Bill of Materials + Inbound Freight | $18,500,000 | Product cost |
Warehousing/ Packaging/ Returns | $3,000,000 | Fulfilment & reverse logistics |
Third-party APIs/ Processing | $1,000,000 | Payments/data/API tied to delivery |
Total COGS | $22,500,000 | |
Gross Profit | $27,500,000 | Revenue - COGS |
Gross Margin (%) | 55% | (27.5 ÷ 50.0) × 100 |
Notes
Don’t mix bases: If revenue is non-GAAP, COGS must be non-GAAP (with reconciliation).
Pass-throughs: If you gross up revenue for pass-through items, include matching costs in COGS (or report net).
Multi-product: Track margin by SKU/plan/channel; blended margins can hide leakage.
Worked Example
Line item | Amount | Notes |
|---|---|---|
Revenue | $50,000,000 | Per policy (GAAP or non-GAAP; match with COGS) |
Inventory/ Bill of Materials + Inbound Freight | $18,500,000 | Product cost |
Warehousing/ Packaging/ Returns | $3,000,000 | Fulfilment & reverse logistics |
Third-party APIs/ Processing | $1,000,000 | Payments/data/API tied to delivery |
Total COGS | $22,500,000 | |
Gross Profit | $27,500,000 | Revenue - COGS |
Gross Margin (%) | 55% | (27.5 ÷ 50.0) × 100 |
Notes
Don’t mix bases: If revenue is non-GAAP, COGS must be non-GAAP (with reconciliation).
Pass-throughs: If you gross up revenue for pass-through items, include matching costs in COGS (or report net).
Multi-product: Track margin by SKU/plan/channel; blended margins can hide leakage.
Best Practices
Fix the rulebook. Publish what counts in Revenue (net of discounts/returns/taxes) and what sits in COGS/Cost of Sales; use it everywhere.
Keep delivery costs in COGS. Hosting/CDN, payment processing, third-party APIs, inbound freight, packaging, warranty/returns — don’t bury these in OpEx.
Be consistent on shipping. If you net shipping in revenue, keep matching costs in COGS; if not, label the result Adjusted Gross Margin and reconcile.
Update unit costs monthly. True-up inventory, returns/warranty reserves, cloud rate cards, and usage variances so margin isn’t distorted later.
Segment the view. Track margin by product/SKU, customer segment, channel, and region; review price–mix–volume–cost drivers each period.
Show % and dollars. Publish Gross Profit ($) and Gross Margin (%); monitor incremental margin on new revenue.
Discount guardrails. Enforce price floors/margin bands; review outlier deals.
Label non-GAAP clearly. If you present “Adjusted” gross margin, define adjustments and reconcile to GAAP.
Best Practices
Fix the rulebook. Publish what counts in Revenue (net of discounts/returns/taxes) and what sits in COGS/Cost of Sales; use it everywhere.
Keep delivery costs in COGS. Hosting/CDN, payment processing, third-party APIs, inbound freight, packaging, warranty/returns — don’t bury these in OpEx.
Be consistent on shipping. If you net shipping in revenue, keep matching costs in COGS; if not, label the result Adjusted Gross Margin and reconcile.
Update unit costs monthly. True-up inventory, returns/warranty reserves, cloud rate cards, and usage variances so margin isn’t distorted later.
Segment the view. Track margin by product/SKU, customer segment, channel, and region; review price–mix–volume–cost drivers each period.
Show % and dollars. Publish Gross Profit ($) and Gross Margin (%); monitor incremental margin on new revenue.
Discount guardrails. Enforce price floors/margin bands; review outlier deals.
Label non-GAAP clearly. If you present “Adjusted” gross margin, define adjustments and reconcile to GAAP.
Best Practices
Fix the rulebook. Publish what counts in Revenue (net of discounts/returns/taxes) and what sits in COGS/Cost of Sales; use it everywhere.
Keep delivery costs in COGS. Hosting/CDN, payment processing, third-party APIs, inbound freight, packaging, warranty/returns — don’t bury these in OpEx.
Be consistent on shipping. If you net shipping in revenue, keep matching costs in COGS; if not, label the result Adjusted Gross Margin and reconcile.
Update unit costs monthly. True-up inventory, returns/warranty reserves, cloud rate cards, and usage variances so margin isn’t distorted later.
Segment the view. Track margin by product/SKU, customer segment, channel, and region; review price–mix–volume–cost drivers each period.
Show % and dollars. Publish Gross Profit ($) and Gross Margin (%); monitor incremental margin on new revenue.
Discount guardrails. Enforce price floors/margin bands; review outlier deals.
Label non-GAAP clearly. If you present “Adjusted” gross margin, define adjustments and reconcile to GAAP.
FAQs
What goes in COGS for Gross Margin?
Only costs required to deliver the product/service (e.g., BOM/materials, hosting, processing, inbound freight, packaging, returns/warranty).Is Gross Margin GAAP or non-GAAP?
GAAP gross margin is standard. “Adjusted” is non-GAAP—clearly label and reconcile.Shipping and payment fees — COGS or OpEx?
If they’re necessary to fulfill/deliver, put them in COGS for comparability.Gross Margin vs Contribution Margin?
Gross Margin subtracts COGS only. Contribution Margin subtracts all variable costs (may include some OpEx).Gross Margin vs EBITDA/Operating Margin?
EBITDA/Operating Margin also deduct OpEx (S&M, R&D, G&A). Gross Margin doesn’t.Does scale always improve margin?
Often, but mix shifts and discounting can offset scale; use a driver bridge to see why margin moved.Why does Gross Margin matter for CAC Payback/Rule of 40?
Higher gross margin → higher gross profit/customer → faster CAC payback and better EBITDA/FCF, improving Rule of 40.Can gross margin be negative?
Yes—deep discounting, high returns, or variable costs exceeding price can drive negative margin.Do pass-through items inflate margin?
They can if revenue is grossed up without matching costs. Prefer net reporting or include the matching COGS.
FAQs
What goes in COGS for Gross Margin?
Only costs required to deliver the product/service (e.g., BOM/materials, hosting, processing, inbound freight, packaging, returns/warranty).Is Gross Margin GAAP or non-GAAP?
GAAP gross margin is standard. “Adjusted” is non-GAAP—clearly label and reconcile.Shipping and payment fees — COGS or OpEx?
If they’re necessary to fulfill/deliver, put them in COGS for comparability.Gross Margin vs Contribution Margin?
Gross Margin subtracts COGS only. Contribution Margin subtracts all variable costs (may include some OpEx).Gross Margin vs EBITDA/Operating Margin?
EBITDA/Operating Margin also deduct OpEx (S&M, R&D, G&A). Gross Margin doesn’t.Does scale always improve margin?
Often, but mix shifts and discounting can offset scale; use a driver bridge to see why margin moved.Why does Gross Margin matter for CAC Payback/Rule of 40?
Higher gross margin → higher gross profit/customer → faster CAC payback and better EBITDA/FCF, improving Rule of 40.Can gross margin be negative?
Yes—deep discounting, high returns, or variable costs exceeding price can drive negative margin.Do pass-through items inflate margin?
They can if revenue is grossed up without matching costs. Prefer net reporting or include the matching COGS.
FAQs
What goes in COGS for Gross Margin?
Only costs required to deliver the product/service (e.g., BOM/materials, hosting, processing, inbound freight, packaging, returns/warranty).Is Gross Margin GAAP or non-GAAP?
GAAP gross margin is standard. “Adjusted” is non-GAAP—clearly label and reconcile.Shipping and payment fees — COGS or OpEx?
If they’re necessary to fulfill/deliver, put them in COGS for comparability.Gross Margin vs Contribution Margin?
Gross Margin subtracts COGS only. Contribution Margin subtracts all variable costs (may include some OpEx).Gross Margin vs EBITDA/Operating Margin?
EBITDA/Operating Margin also deduct OpEx (S&M, R&D, G&A). Gross Margin doesn’t.Does scale always improve margin?
Often, but mix shifts and discounting can offset scale; use a driver bridge to see why margin moved.Why does Gross Margin matter for CAC Payback/Rule of 40?
Higher gross margin → higher gross profit/customer → faster CAC payback and better EBITDA/FCF, improving Rule of 40.Can gross margin be negative?
Yes—deep discounting, high returns, or variable costs exceeding price can drive negative margin.Do pass-through items inflate margin?
They can if revenue is grossed up without matching costs. Prefer net reporting or include the matching COGS.
Related Metrics
Parents: Revenue, COGS / Cost of Sales
Children / Components:
Gross Profit ($), Revenue, COGS
Gross Margin by Product/SKU, by Segment, by Channel/Region — standard cuts of the same metric for mix analysis
Commonly mistaken for:
Contribution Margin (revenue minus variable costs, divided by revenue; excludes fixed production/ fulfillment costs that are included in COGS/Cost of Sales for Gross Margin)
EBITDA Margin (EBITDA ÷ revenue; includes operating expenses such as R&D, S&M, and G&A —well below Gross Margin, which excludes operating expenses)
Net Income Margin (net income ÷ revenue; includes interest, taxes, and all non-operating items —much farther below Gross Margin)
Related Metrics
Parents: Revenue, COGS / Cost of Sales
Children / Components:
Gross Profit ($), Revenue, COGS
Gross Margin by Product/SKU, by Segment, by Channel/Region — standard cuts of the same metric for mix analysis
Commonly mistaken for:
Contribution Margin (revenue minus variable costs, divided by revenue; excludes fixed production/ fulfillment costs that are included in COGS/Cost of Sales for Gross Margin)
EBITDA Margin (EBITDA ÷ revenue; includes operating expenses such as R&D, S&M, and G&A —well below Gross Margin, which excludes operating expenses)
Net Income Margin (net income ÷ revenue; includes interest, taxes, and all non-operating items —much farther below Gross Margin)
Related Metrics
Parents: Revenue, COGS / Cost of Sales
Children / Components:
Gross Profit ($), Revenue, COGS
Gross Margin by Product/SKU, by Segment, by Channel/Region — standard cuts of the same metric for mix analysis
Commonly mistaken for:
Contribution Margin (revenue minus variable costs, divided by revenue; excludes fixed production/ fulfillment costs that are included in COGS/Cost of Sales for Gross Margin)
EBITDA Margin (EBITDA ÷ revenue; includes operating expenses such as R&D, S&M, and G&A —well below Gross Margin, which excludes operating expenses)
Net Income Margin (net income ÷ revenue; includes interest, taxes, and all non-operating items —much farther below Gross Margin)
Back to Metric-dictionary
Index