SaaS Gross Margin Definition
Gross margin is the difference between what you pay for a product or service and what you charge for it. It’s expressed as a percentage of revenue, so it tells you how much profit there is in relation to each dollar of sales.
To calculate your gross margin, subtract the amount you spent to produce your goods from the amount of money you made from selling them. Then divide that number by your revenue.
Why is Gross Margin Important?
Gross margin can help you determine how much you’re making off each dollar of product sold, and it can also be used to calculate your overall profit margin.
For example, if you sell a product for $100 and pay $20 in costs to produce it (cost of goods sold), your gross margin would be 80% ($80/ $100). The lower your cost per unit and the higher your selling price, the greater our gross margin will be. A high gross margin can help offset any upfront costs associated with building out new features for customers, such as marketing or R&D efforts that don’t result in immediate revenue but may lead to long-term growth down the road.
SaaS Cost of Goods Sold (COGS)
Cost of Goods Sold (COGS) is the cost of the product you sell. It includes all direct costs like manufacturing, distribution, and selling costs. For example, if you produce and sell toothpaste, your COGS would be the cost of materials used to produce the toothpaste along with all other direct labor, overhead, and distribution expenses related to making this product.
COGS is a great metric because it tells us how much we have paid out to make our products/services so far in order for them to reach customers’ hands (or mouths). This makes it easy for SaaS companies that charge on a subscription basis since they only pay their COGS once per subscription period instead of paying upfront when customers purchase their subscriptions upfront before using any service at all.
The Gross Margin Calculation
Step 1: Calculate the cost of goods (COG) for each product line. This includes all expenses related to your products or services’ development, marketing, and sales. You may have multiple products or services, so this step will be repeated for each one.
Step 2: Subtract COGS from revenue to get gross profit, which is what you keep after paying all your business expenses.
Step 3: Deduct any operating costs from gross profit to arrive at operating income, which represents how much money you have leftover after paying all your bills but before paying taxes and other expenses. Investors use operating income, also known as EBITDA (earnings before interest, taxes, depreciation, and amortization), to assess the value of companies with no profits yet but significant revenue growth potential.
The traditional way of calculating your SaaS gross margin is by subtracting your variable costs from your revenue and dividing them by the total revenue. But you can also use this simple formula:
Gross Margin = Revenue – COGS
Example:
Revenue: $10,000
COGS: $5,000 ($2,500 in product costs + $2,500 in service costs)
Gross Margin = $5,000 – $10,000 = -$4,000
We have also written a detailed blog on EBTIDA, Gross Margin, and Net Profit. You can check it out if you are still unclear about these terms.
Top 5 Ways to Improve Gross Margin
1. Increase Pricing
You can’t increase the price of your product or service without losing customers, but you can charge more for it by improving the value of what’s being sold and increasing the perceived value to the customer. By making small improvements to your product or service that add up to a big difference in how it helps users’ lives, you’ll be able to charge more for those products and still retain most of your existing customers as well as attract new ones who will pay more than they have been before.
2. Decrease Cost of Goods Sold (COGS)
This one is pretty straightforward: if you’re selling 10 units at a time, but it costs $100 each time someone buys one unit, then there isn’t much profit left once all those COGS are paid off! If there’s an alternative method that uses cheaper materials or less labor involved in producing each unit without sacrificing quality too much, then this might be something worth exploring further; otherwise, keep researching until something better comes along.
3. Improve Your Product
You can increase your gross margin by improving the product or service you are selling. This can include adding features to the product, improving customer service and support, and increasing the quality of your marketing materials. When you improve your product, you may be able to charge more for it, which will increase your revenue and gross profit.
4. Reduce Operational Costs
Operational costs include everything from salaries, employee benefits, rent, utilities, and equipment maintenance. You can reduce these costs by hiring fewer employees or outsourcing certain tasks that don’t require full-time employees (e.g., telemarketing).
Look at every aspect of your business and see where you can cut costs without sacrificing quality. For example, if you provide services at a high price point, consider offering lower-cost services as well.
You should also optimize all your processes so they work more efficiently, which will increase productivity and reduce mistakes made by people working in your company. Hiring freelancers who work remotely can also help reduce operational costs.
5. Increase Volume
If you sell more products, your overall profits will increase. You can increase volume by offering discounts or free shipping, but these may not be sustainable long-term strategies.
What is a SaaS Gross Margin Roadmap?
A SaaS Gross Margin Roadmap is a plan for increasing your SaaS gross margin. The roadmap should be based on your current SaaS gross margin and the growth rate of your business.
The first step is to calculate the average monthly revenue per customer to determine what expenses can be avoided when onboarding new customers and which expenses will increase as you onboard more customers. This will help you identify what costs need to decrease or stay flat in order for you to achieve your goal of increasing the gross margin percentage over time.
Conclusion
We hope we have cleared all your queries and confusion related to SaaS gross margin and how to calculate it easily. We have also highlighted the importance of understanding your SaaS gross margin. It will allow you to make better business decisions in terms of pricing and product development.
With these tips and easy formula in mind, hopefully, you can effectively calculate your SaaS gross margin and help your company gain more insights into its financial health!