How to understand and improve your business's gross margin

Revenue can grow while your business becomes less profitable. Higher material, supplier, freight, wage and wastage costs can quietly absorb the extra money. Gross margin shows how much revenue remains after the direct costs of making or delivering what you sell, making it a practical starting point for stronger margins.

A gross margin review turns a broad worry about profitability into specific decisions about prices, purchases, waste and the mix of work you accept. The process works best when you use consistent figures, review them regularly and act on the largest opportunities first.

Start with the economics of gross margin

Gross profit is revenue minus cost of goods sold, often abbreviated COGS. Gross margin expresses that profit as a percentage of revenue, so two businesses with the same sales can have very different economics. Use it to compare products, services and customer groups rather than relying on total turnover.

For a business with A$120,000 in revenue and A$72,000 in COGS, gross profit is A$48,000 and gross margin is 40%: divide A$48,000 by A$120,000. That differs from a 66.7% markup on the A$72,000 cost. Confusing the two measures can make pricing decisions look healthier than they are.

The percentage also tells you how much room remains for operating expenses such as administration, rent, marketing and non-production wages. A business with a 25% gross margin and one with a 45% gross margin need very different sales volumes to cover the same overhead. Margin exposes that difference before cash flow becomes urgent.

Calculate cost of goods sold accurately

For a product seller, COGS usually includes the cost of inventory sold, plus direct costs such as inbound freight, customs charges, insurance and sale-ready packaging. Work out a consistent landed cost for each item so purchasing prices, wastage and selling prices can be compared on the same basis. Update it when exchange rates, freight or supplier terms change.

For a service business, COGS can include production staff, billable contractors, project materials and cloud hosting used to deliver the work. Australian tradespeople often quote labour and materials separately, which makes this split easier. Keep general administration, rent and most sales and marketing costs outside COGS unless your accounting policy consistently treats them as direct costs.

Two Australian checks belong in this process. If you are registered for GST, record standard-rated sales excluding GST and account for the 10% tax through your Business Activity Statement. For staffing, check applicable Fair Work award pay, employer superannuation and workers' compensation cover, then apply a consistent treatment to direct labour on-costs so costs are not shifted merely to improve the percentage.

Review prices and the revenue mix

Not every revenue dollar carries the same value. A product with a high percentage may still be weak if it consumes scarce production hours, while a lower-margin service may be profitable because it uses those hours well. Compare gross profit per unit, per project and per productive hour, and include the effect of discounts, refunds and payment terms.

Test a modest price rise where customer value and competitor pricing support it. Explain the change clearly, apply it to new quotations first, and watch conversion and order volume. Under the Australian Consumer Law, prices and discount claims must not mislead consumers, and the Australian Competition and Consumer Commission can scrutinise false reference prices or exaggerated savings. Genuine, supportable value is a stronger basis for pricing than an unsupported premium label.

Review the mix as well as the price. Bundles can lift average order value, yet the discount inside a bundle may consume the extra gross profit it creates. Before rebuilding a service package or product range, a quick design sprint can help test the offer, customer experience and commercial assumptions before you commit stock or campaign spend.

Negotiate supplier and purchasing terms

A lower invoice price does not always produce a lower cost of sale. Add freight, insurance, minimum-order charges, payment fees, storage and expected spoilage to the supplier quote. For imported goods, account for the full landed cost and currency exposure rather than comparing the sticker price with a local wholesale price.

Approach a supplier with evidence: the volume you can commit to, the payment terms you can meet and the prices you have benchmarked. SCORE's negotiation guidance provides a practical way to prepare, ask for alternatives and preserve the relationship. Negotiate unit price, freight, rebates and due dates separately because improving one term can otherwise reduce another.

Turn the agreed terms into a buying process. Record the effective cost, standard lead time, minimum order quantity and price-review date, then compare suppliers using the same total-cost calculation. Avoid chasing a discount that creates excess stock or a switching cost larger than the saving, particularly for slow-moving lines that already tie up working capital.

Reduce waste, stock and fulfilment costs

Inventory becomes part of COGS when it is sold, so purchasing decisions eventually affect the margin recorded on each sale. A busy stockroom can hide slow-moving items that need discounts, expire or must be written down. Keep a list of ageing stock, set purchase limits for weak lines and clear obsolete products before their value falls.

Measure the waste that happens after a product reaches your premises. Record spoilage, damage, returns, remake rates and the reasons behind them, then separate supplier quality problems from handling or forecasting failures. A small cafe can reduce portion variance, while a manufacturer can change cutting plans or packaging sizes. The common approach is to assign a cause, owner and target reduction to each significant loss.

Fulfilment costs deserve the same attention. Count the variable labour, protective packaging, direct freight and payment charges involved in each order, then compare them with the revenue and contribution from that order. If some fulfilment work is genuinely part of delivering the sale, include it consistently in COGS; if it supports general operations, record it as an operating expense rather than manipulating the margin calculation.

Track margin by product, customer and channel

A single blended percentage can conceal weak combinations. Calculate the margin for each major product, service, customer type and sales channel, especially where commissions, discounts or custom work differ. This reveals which offerings support the business and which merely increase workload. Review the data monthly, because material price changes and sales mix can alter the result quickly.

Set three core measures for each segment: revenue, COGS and gross profit per productive hour. Add the gross profit percentage so a large but low-margin order does not automatically look better than a smaller, stronger one. Compare Sydney and Melbourne operations with similar local peers, since wage, freight and supplier baselines vary by city and a distant benchmark can encourage the wrong pricing response.

Use the results to choose a response. A weak margin may reflect a price problem, a supplier problem, too much waste or a product that no longer fits the market. A small corrective action, such as repricing a service, changing materials or stopping a low-margin custom order, can produce a larger effect than a broad cost-cutting campaign that distracts from the real cause.

Build a 90-day gross margin action plan

Start with a reliable baseline and one or two measurable priorities. A practical first target is to raise margin without damaging customer relationships, cash flow or service quality. Rank opportunities by likely financial gain and ease of implementation, then assign an owner and review date so the work does not disappear into everyday operations.

• Calculate the latest quarterly gross margin and the margin for each major product, service and customer type.
• Identify the three biggest COGS drivers, including waste, freight and supplier discounts, and verify their current costs.
• Test a targeted price adjustment or revised offer on a small group of new customers and track the response.
• Agree on a margin target, monitor it monthly and investigate any segment that falls below the agreed threshold.

Explore the free business workshops for practical guidance, then request a one-on-one session with a SCORE Nashville volunteer mentor to review your figures. Bring a sales summary, supplier invoices and your current cost calculation. That focused review can produce a prioritised 90-day plan, a clear owner for each action and a way to measure whether the improvement holds.