Gross Profit Formula for E-commerce: The Most Important Metric for Your Ads

The Foundation of Profitable Advertising

If you're running ads for your e-commerce store, understanding your gross profit margin isn't just helpful—it's essential. This metric determines how much you can spend to acquire customers while remaining profitable.

What is Cost of Goods Sold (COGS)?

COGS represents what it costs you to make or buy your product. This includes:

• Manufacturing costs
• Wholesale price
• Shipping to your warehouse

It does NOT include:

• Marketing costs
• Overhead (rent, salaries, etc.)
• Shipping to customers

For example, if you sell a product for $100 and it costs you $40 to make or buy it, your COGS is $40.

Understanding Gross Margin

Gross Margin is the percentage of revenue that remains after subtracting COGS. Here's how to calculate it:

In our example:

• Revenue = $100
• COGS = $40
• Gross Margin = ($100 - $40) ÷ $100 = 0.6 or 60%

This metric is tied directly to the sale of a product and doesn't include your fixed costs (rent, software, etc.). It tells you how much you can spend to get a sale before paying the extra costs.

Unlike fixed costs which become easier to pay as your revenue grows, your gross margin stays the same as you scale. If you pay $5,000 in warehousing, this stays the same whether you sell 100 or 1,000 products, so the per-unit impact of rent decreases as sales increase. But your gross margin remains constant regardless of volume.

Breakeven ROAS: Your Advertising North Star

Tied directly to your gross margin is breakeven ROAS (Return on Ad Spend). This tells you exactly how much revenue you need to generate from ads to cover your COGS.

Using our example:

• Gross Margin = 60%
• Breakeven ROAS = 1 ÷ 0.6 = 1.67

This means for every $1 you spend on ads, you need to generate $1.67 in revenue just to break even on COGS.

How Gross Margin Affects Your Breakeven ROAS

You want to aim for a gross margin of 50% so that your breakeven ROAS is 2.0. That's because it's far easier to get a 2.0 ROAS and work on your margins than it is to get a 3.0 ROAS from optimizing your Google Ads strategy.

This is where many brands fail, and is an area worth focusing on for your business.

Action Steps: Calculating Your Numbers

1. Calculate COGS for your top sellers:
   • Log into your Shopify dashboard
   • Navigate to Analytics >> Reports >> Total Sales By Product
   • For your 10 best-selling products, calculate the COGS
   • If you're already running Google Ads, also identify your 10 best-performing products there and do the same
2. Calculate gross margin and breakeven ROAS for these top products:
   • Use our ROAS Calculator to calculate your breakeven ROAS values for individual products or collections
   • Save these values somewhere you'll remember
3. Set benchmark targets for other products:
   • If you are advertising other collections/products but don't have time to work out their individual COGS, set an average
   • If you've structured your campaigns by price point/category/margin, assign a COGS for that group of products
4. How to use this data:
   • Flag products where the math doesn't work - these either need margin improvements or should be excluded from ad campaigns
   • Make a note of your best-selling products that have the best gross margins. These are the ones you should really try and push on Google Ads
   • Keep this information handy for when you develop your advertising strategy and structure