Gross Margin

Gross margin — definition and purpose

Gross margin (or gross profit margin) is the percentage of revenue a company retains after covering the direct costs of producing its goods or services. It measures how efficiently a business converts sales into gross profit before accounting for operating expenses, interest, and taxes.

Key points:
* Shows the portion of each dollar of revenue remaining after cost of goods sold (COGS).
* Useful for assessing production efficiency and pricing strategy.
* Helps investors and managers compare profitability across companies or time periods.

Formula and calculation

Gross margin (%) = (Gross profit ÷ Net sales) × 100

Where:
* Gross profit = Net sales − Cost of goods sold (COGS)
* Net sales = Total revenue after discounts and returns
* COGS = Direct costs of production (materials, direct labor, manufacturing supplies)

Example:
* Revenue: $200,000
COGS: $100,000
Gross profit = $200,000 − $100,000 = $100,000
* Gross margin = ($100,000 ÷ $200,000) × 100 = 50%

What gross margin tells you

Gross margin indicates how much money is available from sales to cover operating expenses, interest, taxes, and profit distributions after direct production costs are paid. A higher gross margin means more funds remain per dollar of revenue to support the rest of the business.

Actions companies might take when margin falls:
* Reduce direct labor or find cheaper suppliers
* Improve production efficiency
* Increase product prices (if market allows)

Gross margin also supports comparisons:
* Across time to monitor trends in production efficiency
* Between competitors or industry peers to evaluate relative cost structures

Gross margin vs. net margin

• Gross margin focuses only on revenue and COGS (production-related costs).
• Net margin (net profit margin) accounts for all expenses, including operating expenses, interest, taxes, and non-operating items.
  Use gross margin to assess production profitability; use net margin to assess overall business profitability.

Gross margin vs. gross profit

• Gross profit is a dollar amount: revenue minus COGS.
• Gross margin is that gross profit expressed as a percentage of revenue.
  Both draw from the same inputs but serve different reporting and comparison purposes.

What is a good gross margin?

There is no universal “good” margin—acceptable levels vary widely by industry:
* Service-based businesses typically have higher gross margins because they have lower COGS.
* Manufacturing and retail often have lower gross margins due to significant material and production costs.
Compare a company’s gross margin to industry peers and historical performance to judge acceptability.

Conclusion

Gross margin is a core profitability metric that reveals how effectively a company turns revenue into gross profit after direct production costs. It’s essential for internal cost management, pricing decisions, and investor evaluation, but should be interpreted in context with industry norms and other profitability measures such as net margin.