What Gross Profit Actually Tells You
Gross profit is the money left after you pay for the direct costs of producing your product or delivering your service. It's the first filter on your income statement, and it's arguably the most important one.
If your gross margin is unhealthy, nothing downstream can fix it. You can cut overhead, reduce your salary, defer maintenance, skip marketing — but if the fundamental economics of each sale don't work, you're running a charity, not a business.
Think of gross profit as the raw material your business has to work with. Every dollar of overhead, every dollar of owner compensation, every dollar of net profit, and every dollar of tax must come from gross profit. If the pool is too small, everything downstream gets squeezed.
Gross Profit vs Net Profit
These are fundamentally different numbers, and confusing them is a common mistake:
- Gross profit = Revenue minus cost of goods sold (COGS). This covers only direct costs: materials, direct labor, manufacturing, subcontractors. It tells you how much each sale contributes before overhead.
- Net profit = Revenue minus all costs: COGS, overhead, rent, insurance, utilities, marketing, office staff, owner salary, interest, and taxes. It tells you what the business actually earned.
A business can have a healthy gross margin and still lose money if overhead is too high. Conversely, a business with a thin gross margin can still be profitable if it operates with extremely low overhead. Both numbers matter, but gross margin is the foundation.
Industry Benchmarks
Gross margins vary dramatically by industry. Here are typical ranges based on data from the U.S. Census Bureau Annual Business Survey and the Bureau of Labor Statistics Industry at a Glance:
| Industry | Typical Gross Margin | Notes |
|---|---|---|
| Retail | 25 - 50% | Varies widely by category; grocery is low, apparel is high |
| SaaS / Software | 70 - 80% | Low marginal cost per user; high R&D overhead instead |
| Manufacturing | 25 - 35% | Heavy material and labor costs; volume is key |
| Restaurants | 30 - 40% | Food cost typically 60-70% of menu price |
| Construction / Trades | 25 - 40% | Materials and labor intensive; equipment costs add up |
| Professional Services | 50 - 70% | Low COGS but high labor cost often classified as overhead |
If your gross margin is significantly below your industry benchmark, you are either underpricing or your direct costs are out of control. Both problems are solvable, but you have to identify which one it is first.
What to Do With This Number
Knowing your gross margin is step one. Acting on it is where the value lives:
- Track it monthly. Gross margin should be a number you know off the top of your head, not something you look up once a year at tax time.
- Track it per product or service line. An overall 35% margin might hide the fact that one service line runs at 55% and another at 15%. Kill or fix the underperformers.
- Set a floor. Decide the minimum gross margin you'll accept on any job or product. Turn down work that falls below it. The SBA recommends building this floor into your pricing strategy from day one.
- Negotiate direct costs. If your margin is thin, look at your top three direct cost categories. A 5% reduction in materials cost flows directly to gross profit.
- Raise prices. This is the lever most owners resist, but it is often the most effective. A 10% price increase on a product with 30% margins increases gross profit by 33%.
The Gross Margin Trap for Service Businesses
Service businesses often struggle with gross margin because the line between direct costs and overhead gets blurry. Is a project manager's salary a direct cost or overhead? What about the truck a technician drives?
The rule of thumb: if the cost goes away when you stop doing the work, it's a direct cost (COGS). If it stays even when you have no jobs, it's overhead. Be honest with yourself about this classification. Stuffing direct costs into overhead artificially inflates your gross margin and gives you a false sense of security.
Sources
- U.S. Census Bureau — Annual Business Survey — Business financial data across industries
- Bureau of Labor Statistics — Industries at a Glance — Industry-level financial and employment data
- U.S. Small Business Administration — Manage Your Finances — Financial management guidance for small businesses