Unleashing Profit Potential: Understanding Gross Margin

Gross Margin

Gross margin is generally the revenue your business left with after subtracting the cost of goods sold. It is expressed as a percentage of the total revenue generated by your company. It is the amount you spend on operating expenses and reinvesting into your business or entrepreneurship.

Estimating your gross margin is mandatory for SaaS businesses, especially starting ones. If you have a higher gross margin at the beginning of your SaaS company, you have greater chances of growing your business rapidly. It is because you will have more money to spend on different departments to raise them well and reinvest in your industry.

This post will tell you about the methods to calculate gross margin, how to improve it, what is considered a fair gross margin, and many other things related to gross margin.

Formula to Estimate Gross Margin

To estimate gross margin, you first need to know the cost of goods sold to generate revenue. It is as COGS. When you calculate COGS, you don’t have to include the price only. Other charges, such as transport, maintenance, hosting, and 3rd party integration, are also included in COGS.

Once you estimate COGS for a month, you can calculate the gross margin. To do so, you must subtract COGS from monthly recurring revenue (MRR) and divide it by income. The numerical value you get will be your gross margin.

Gross Margin Formula

Gross Margin % = Revenue-COGS ÷ Revenue = Gross Profit÷Revenue×100

For Instance, you are running a pen-selling company. The COGS for one of your hot-selling products is $20. Manufacturing, shipping, maintenance, and all other charges are included in it. You sell each pen for $100. So, the gross margin for every pen would be:

Gross Margin = ( $100 – $20 ) $10 = 80%

So your gross margin for that specific product is 80%.

Difference Between Gross Margin and Net Margin

Gross margin and net margin often need to be clarified. However, they are different from each other.

It is the revenue you have after subtracting only COGS from MRR. On the other hand, net margin is the total revenue you have after excluding COGS, additional expenses, taxes, etc.

Net margin gives a more brief account of profitability than because all the expenses are excluded from it, unlike gross margin, which is calculated by excluding COGS only.

“Good” Gross Margin for Your SaaS Company

It’s taught in general mathematics that if you want to make a profit, you must sell products at a higher price than their coat. The more profit you get, the better it will be for your company’s growth.

Generally speaking, you aim to improve your with the growth and success of your SaaS business. When you tend to improve, you have more part of every dollar to reinvest in your company.

For Instance, let’s compare two SaaS companies, A and B. A has 10%, and B has a value of around 80%. So, the one with a 10% has only 10 cents per dollar to reinvest and manage expenses. At the same time, company B has 80 cents per dollar as a profit.

It makes you realize every dollar you earn matters. It has considerable advantages in marketing and other expenditures. That’s why a company worth $20 Millions can have more value than one worth $50 Million.

Benchmarks for Gross Margin of SaaS Companies

Based on business and industrial research reports, the average gross margin for a SaaS company should be around 73%. However, this numerical value may vary depending on your business type, strategies, market trends, etc. For example, enterprise SaaS companies have a better than non-enterprise companies. Most experts suggest you should never aim for a of 80%.

Methods to Improve Gross Margin

A SaaS company can use two effective methods to improve. These are:

  1. Increase revenue
  2. Decrease cost of goods sold (COGS)

You will have a relatively lower when you are just starting your SaaD company for several reasons. However, as you acquire more customers and grow your business, your company’s gross margin also improves. You can support customers at a time, and it reduces COGS directly, improving you.

The methods above improve gross margin work along with each other. You cannot keep decreasing the quality to reduce COGs and increasing prices to enhance revenue. It will lead you to lose most of your potential customers. Always play with numbers in the best possible way. A company with a $1000 MRR but a gross margin of 50% can never be better than a company with an MRR of $700 but a 90%.

Frequently Asked Questions

How to calculate gross margin?

It can be by estimating the COGS. You must subtract COGS from MRR and divide it by total revenue.

Margin = (Total Revenue – COGS) / Total Revenue

Using this formula helps you get a percentage which is a portion of the profit you have after excluding COGS.

What are some benchmarks for SaaS gross margins?

According to experts, the average SaaS company is around 73%. However, this portion may vary based on the nature of your business and the strategies you adopt. For example, enterprise SaaS companies have higher as compared to other categories of SaaS companies.

How can a SaaS company improve its gross margin?

Many strategies can be used to boost of a SaaS company. The best thing companies do in this regard is to reduce COGS and generate more revenue. Improving products and their quality by introducing new and advanced features can do the trick. Customers can spend more on a product that has advanced features.

What is the difference between gross margin and net margin?

It is the profit you have after excluding the COGS. On the other hand, net margin is the percentage of profit you have after excluding COGS along with operation expenses, taxes, and other expenses. It gives a more clear estimate of profitability.

Read More:  5 Long Term Business Goals to See Growth

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