What is gross margin and why should I care?
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- 1.How to read your numbers when you hate numbers
- 2.What is gross margin and why should I care?
Gross margin is what's left of each sale after the direct cost of delivering it. Here's what it means in plain English, why it matters in one line, and a simple % example.
What gross margin actually is
Gross margin is what's left of each sale after you've paid the direct cost of delivering it.
That's the whole idea. Make a sale, subtract what it cost you to fulfil that specific sale, and whatever's left is your gross margin. It's the slice of every pound of revenue that stays in the business before you've paid for anything else.
Think of a market stall selling sandwiches. You sell a sandwich for £5. The bread, filling and wrapper cost you £2. That £3 left over is your gross margin on that sandwich. It hasn't paid for your stall pitch, your time, or your van yet — but it's the money the sandwich itself generated. Sell enough sandwiches with a healthy gap between price and ingredients, and there's something left to cover everything else. Sell them at £2.50 when the ingredients cost £2, and you're working incredibly hard for almost nothing.
That gap — price minus the direct cost of delivering it — is gross margin. Everything else about your business is built on top of it.
Why you should care (in one line)
Here it is, the whole reason this number matters:
Gross margin tells you whether the core of your business actually makes money before you've paid a single overhead.
If your gross margin is healthy, every sale genuinely helps you. If it's thin, you're on a treadmill — selling more just means more work for the same nothing, and no amount of "growth" will save you. Founders are often shocked to discover that their busiest, fastest-growing product is the one quietly losing money on every sale, because nobody ever checked the margin.
The direct costs (and the ones that don't count)
The trickiest part of gross margin is knowing which costs to subtract. The rule is simple: only the costs that go up and down with each sale.
These direct costs are called cost of goods sold, or COGS (the cost of actually producing or delivering what you sold). For our sandwich stall, that's the bread, filling and wrapper — the more sandwiches you sell, the more you spend on these.
What does not count are your fixed overheads — the costs you'd pay whether you sold one sandwich or a thousand. Your stall rent, your insurance, your phone bill, your accounting software: these are real costs, but they're not part of gross margin, because they don't rise and fall with each individual sale. They get paid out of the gross margin you've earned, not before it.
A quick translation for different businesses:
- A product business: direct costs are materials, manufacturing, packaging and shipping.
- A software business: direct costs are hosting, payment processing fees, and any per-customer support or licences.
- A service business: direct costs are the wages or contractor fees for the people actually doing the billed work.
If you're unsure whether a cost is "direct," ask one question: if I made one more sale, would this cost go up? If yes, it's a direct cost. If no, it's an overhead and it stays out of gross margin.
A simple percentage example
Margin is usually talked about as a percentage, because a percentage lets you compare things of different sizes. Here's how to get it.
Say you sell a product for £100. The direct cost of delivering it — materials, packaging, shipping — comes to £40.
Your gross profit on that sale is:
£100 − £40 = £60.
Now turn it into a percentage by dividing the gross profit by the sale price:
£60 ÷ £100 = 60%.
So your gross margin is 60%. In plain English: for every £1 of sales, 60p stays in the business to cover your overheads and, hopefully, leave a profit. The other 40p went straight back out as the cost of delivering the sale.
That single number — 60% — is now something you can track over time and compare across products. If next quarter your costs creep up and the same £100 sale only leaves £50, your margin has dropped to 50%, and you'd want to know why before it eats your whole year. A percentage makes that slide visible in a way the raw pounds don't.
What's a "good" gross margin?
The honest answer is: it depends entirely on your industry, so be careful comparing yourself to others.
A software business often runs at 70–90%, because once the product is built, delivering it to one more customer costs very little. A retailer or restaurant might run at 20–40%, because every sale eats real ingredients or stock. A service business sits somewhere in between, depending on how much of the work is people's time.
So don't panic if your margin isn't 80% — for many perfectly healthy businesses, it shouldn't be. The two comparisons that actually matter are: is my margin holding steady or slipping over time? and is it typical for my type of business? A stable, normal-for-your-sector margin is the goal. A margin that's quietly drifting down month after month is the warning sign worth catching early.
Why margin and cash are different things (and both matter)
Gross margin tells you whether each sale is fundamentally worthwhile. It does not tell you whether you've got money in the bank today — that's cash, and it's a separate question. You can have a beautiful 70% margin and still be short of cash because your customers haven't paid you yet.
That's why margin sits alongside your other key numbers rather than replacing them. Margin answers "is the model sound?" Cash and runway answer "can I pay the bills this month?" A strong founder watches both: margin to know the business deserves to survive, cash to make sure it gets to. (See: Profit vs cash — why you can be profitable and still broke.)
The short version
Gross margin is what's left of each sale after the direct cost of delivering it — price minus the costs that rise and fall with each sale. Express it as a percentage by dividing gross profit by the sale price. It matters because it tells you whether the core of your business makes money before overheads. Compare it to your own past and your own industry, and watch for it quietly slipping.
Ready to stop guessing your margins? In Ledgers, your numbers are organised automatically from your bank feed and invoices, so you can see what each sale really leaves you — without building a spreadsheet or learning accounting. See your numbers without learning accounting → start free.
Next, the number that decides how long you've got: What is runway and how do I work out mine? →
Feeling overwhelmed by all of this? Start here: How to read your numbers when you hate numbers →
Frequently asked questions
What is gross margin in simple terms?
It's the slice of each sale that's left after you subtract the direct cost of delivering that sale. Sell for £100, spend £40 delivering it, and your gross margin is £60, or 60%.
How do I calculate gross margin?
Subtract your direct costs (cost of goods sold) from your sale price to get gross profit, then divide that by the sale price. £60 gross profit on a £100 sale is a 60% margin.
What's the difference between gross profit and gross margin?
Gross profit is the pounds left over (£60). Gross margin is that figure as a percentage of the sale (60%). The percentage lets you compare products and track changes regardless of size.
What counts as a direct cost?
Any cost that rises and falls with each sale — materials, shipping, payment fees, or the labour doing the billed work. Fixed overheads like rent, insurance and software are not direct costs and stay out of gross margin.
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