Gross margin is revenue minus the cost of goods sold, divided by revenue. As a formula: gross margin = (revenue − COGS) ÷ revenue. A bearing sold at $16.90 that cost $11.60 to land has a gross margin of 31.4%. The same formula works for one quote line, one customer, or the whole business, and using it per line is how distributors find where margin is made and lost.
The gross margin formula
Gross profit is the dollar amount, revenue minus cost of goods sold: $5.30 on the bearing. Gross margin is that profit as a share of revenue. For a distributor, cost of goods sold should be landed cost: what you paid the supplier plus freight in, duty and handling. The landed cost guide shows why using the supplier price overstates margin.
Worked examples
- A business with $4.2 million of sales and $3.1 million of cost of goods sold has a gross margin of ($4.2M − $3.1M) ÷ $4.2M = 26.2%.
- A quote line of 300 bearings at $16.90 with a landed cost of $11.60 has revenue of $5,070, cost of $3,480 and a gross margin of 31.4%.
- To hit a 35% margin on an item that costs $8.40, price it at $8.40 ÷ 0.65 = $12.92.
Gross margin, operating margin and net margin
- Gross marginAfter cost of goods sold26.2%
- Contribution marginAfter all variable costs22.4%
- Operating marginAfter overheads5.1%
- Net marginAfter interest and tax3.6%
Each step down subtracts more costs. The gap between gross margin and operating margin is the cost of running the business. For a distributor that gap is usually most of the gross margin, which is why a single point of gross margin can be a large share of operating profit.
Calculate it per quote line
Most distributors know their gross margin for the month. Few know it for each quote line before the quote goes out, which is where it can still change. Per line, you need three numbers: the price, the quantity, and the landed cost at the time of the sale.
- Use landed cost at the time
The cost of the stock you will actually ship, not last year's standard.
- Show it on the line
Margin in dollars and percent, next to the price, as the rep types.
- Compare with the target
The segment's target margin for that category, and the floor.
- Subtract what follows the sale
Customer rebates and free freight, for the margin you will really keep.
The last step turns gross margin into something closer to contribution margin, the better number for deciding a discount.
A monthly margin report tells you what happened. A margin on the quote line lets you change it.
Gross margin vs markup
Gross margin divides profit by the price; markup divides it by the cost. A 31.4% gross margin is a 45.7% markup. Adding 40% to cost does not give a 40% margin, it gives 28.6%. The margin vs markup guide has a full conversion table.
What is a good gross margin?
It depends on the sector and on your costs. Public distributors range from under 5% in pharmaceuticals to around 45% in fasteners and MRO supplies. The distributor margin guide lists real figures. Within your own business, the more useful comparison is between categories, customers and reps selling the same items, because that is where the differences can be fixed.
Pricing optimization software calculates gross and net margin on every quote line from landed cost, compares it with what similar quotes closed at, and recommends the price that protects it.
Gross margin calculator
- Cost
- $11.60
- Gross profit
- $5.30
Common questions
It means that out of every $100 of sales, $30 is left after paying for the goods that were sold, and $70 went on their cost. The $30 has to cover rent, wages, freight, software and every other cost before any profit is made.
Divide the cost by one minus the margin. For a 40% margin on an item that costs $60, the price is $60 ÷ 0.60 = $100. Adding 40% to the cost gives $84, which is only a 28.6% margin, so always divide rather than multiply.
With the price in A2 and the cost in B2, use =(A2-B2)/A2 and format the cell as a percentage. For the price that gives a target margin, with the cost in B2 and the margin in C2, use =B2/(1-C2).