What it means
Gross margin is the share of each sales dollar left after paying the direct cost of delivering what you sold. At a 75% gross margin, every $1 of revenue leaves 75 cents to pay for product development, sales, overhead and eventually profit.
It's the first measure of profit on the P&L, taken before any of the costs of building and selling the product.
Gross profit is revenue minus cost of revenue. Gross margin is gross profit divided by revenue, shown as a percentage. Use GAAP revenue for the same period on both sides; dividing by ARR mixes a run rate with an actual result.
Gross profit can appear on a GAAP income statement, but the percentage is a ratio you calculate, so treat it as a metric. It's only as reliable as what you put in cost of revenue.
In March, Acme recognizes $100,000 of revenue. Hosting costs $12,000, payment processing $3,000 and support salaries $10,000, so cost of revenue is $25,000. Gross profit is $75,000 and gross margin is 75%. With support left in G&A, margin would read 85%, until a diligence team moved it back.
Investors use it to judge what each new dollar of revenue is worth, and it feeds straight into valuation. They watch the trend too. A margin that falls while revenue grows usually means something like hosting is scaling faster than customers.
Why it matters. It tells investors how much each new dollar of revenue is worth, and it moves valuations. It's only as good as what you put in cost of revenue.
Try it with your numbers
Change any number. The working below updates as you type.
Gross margin = (Revenue − Cost of revenue) ÷ RevenueRecognized revenue, not ARR.
People who keep customers running belong here, not in G&A.
Third-party licenses, data.
Gross margin
75.0%
How it’s worked out
- 1Cost of revenue$12,000 + $3,000 + $10,000 + $0$25,000
- 2Gross profit$100,000 − $25,000$75,000
- 3Gross margin$75,000 ÷ $100,00075.0%
Gross profit is a GAAP line; the margin percentage is a ratio built on it. It's only as honest as what you put in cost of revenue.
Common questions
Is gross margin a GAAP measure?
Gross profit can appear on a GAAP income statement; the percentage is a ratio you calculate from it. What goes into cost of revenue is a policy choice, so state it.
Why did my gross margin drop when revenue grew?
Usually because a cost in cost of revenue grew faster: hosting for a large new customer, a support hire, or higher payment processing fees.
What's a typical SaaS gross margin?
Software companies often report 70% to 80% or more; businesses with heavy services, payments or hardware run lower. Benchmarks only help when cost of revenue is defined the same way, so check what's included before comparing.
Where it comes up
The glossary entries, founder guides and lessons on this site that use the term and link here.
- Gross marginGross margin is a profitability metric, calculated as (Revenue − COGS) ÷ Revenue.Glossary
- How to read an income statement (P&L)Revenue, cost of revenue, gross margin, operating expenses and net income, read line by line, on accrual basis, with the mistakes founders make most.Guide · 7 min
- Chart of accounts for startups: a starting templateA starting chart of accounts for a US startup: number ranges, the expense accounts you need, and when to add an account versus a class or tracking tag.Guide · 6 min
- Cash vs accrual accounting for startups, and the IRS ruleCash or accrual for a startup: why investors and auditors read accrual, when the IRS lets a C-corp file on cash, and the 2026 gross receipts limit.Guide · 5 min
- Payment terms explained: Net 30, discounts and late feesHow to choose payment terms, count a due date, price an early-payment discount, set lawful late fees and work with enterprise procurement.Guide · 6 min
- The income statementTwo of the five account types, arranged so each subtotal answers a different question about how the month went.Lesson 10
Read further
General information for US companies, not tax, legal or accounting advice. Check the specifics with a CPA before you act on them.