TL;DR: Gross margin is the percentage of revenue left after subtracting the direct costs of delivering a product or service (cost of goods sold). It shows how much each dollar of revenue contributes before operating expenses, and it is a key indicator of a business model's underlying profitability.
Gross margin is revenue minus cost of goods sold (COGS), expressed as a percentage of revenue. COGS covers the direct costs of delivering the product, such as hosting, support, and payment processing for a software business. What remains is the gross profit available to cover everything else: sales, marketing, research, and general overhead.
A high gross margin means most of each revenue dollar is available to fund growth and, eventually, profit. Software businesses typically run high gross margins, often 70% to 90%, which is part of what makes them attractive to fund.
Gross margin sets the ceiling on how profitable a company can become and how much room it has to invest in growth. For a lender, strong and stable gross margins indicate a healthy model where revenue translates efficiently into the cash needed to service a facility. Thin or declining gross margins are a warning that scale alone may not produce profitability.
What is the difference between gross margin and net margin? Gross margin subtracts only the direct cost of delivery. Net margin subtracts all costs, including operating expenses, interest, and taxes, to show bottom-line profitability.
What is a healthy gross margin for software? Often in the 70% to 90% range, though it depends on the model and what is included in cost of services and goods sold.
Related terms: EBITDA · Unit Economics · Rule of 40 · Annual Recurring Revenue
