Gross margin definition
Gross Margin is the company's net sales minus the cost of goods sold (COGS). In other words, it is the sales a company retains after it incurs the direct costs associated with the production of the goods. The higher the gross margin, the more capital the company retains per dollar of revenue. These revenues can be used to pay other costs or meet debt obligations. The net sales figure is simply the total sales, minus the profits, allowances, and discounts.
The formula of Gross Margin
Gross Margin = Net Sales − COGS
where:
COGS = Cost of goods sold
Understand gross margin
Gross margin represents the share of every dollar of revenue the company keeps as gross profit. For example, if a company's recent quarterly gross margin is 35%, that means it retains $ 0.35 from every dollar of revenue generated. Because the cost of goods sold has been taken into account, the remaining money can be transferred to pay debts, business management expenses, interest, and dividends to shareholders.
Firms use gross margins to measure production costs relative to sales. For example, if a company's gross profit margin drops, it should reduce its labor costs or look for cheaper material suppliers. Besides, the company may increase the selling price, as a measure of increasing sales. Gross margins can also be used to measure a company's performance or to compare two companies with different market capitalizations.
KEY Factors
- Gross Margin is equivalent to net sales minus cost of goods sold.
- Gross Margin shows the amount of interest made before deducting selling expenses, general and administration expenses.
- Gross Margin can also be displayed as a gross profit as a percentage of net sales.
Gross Margin and Net Margin
While the gross margin focuses only on the relationship between the revenue and the cost of goods sold, the net profit margin takes into account all the costs of the business. When calculating the net margin, the firm subtracts the cost of goods sold as well as ancillary costs such as product distribution, salaries of sales representatives, other operating expenses, and taxes.
Gross margin - also known as the "gross profit margin", helps a company evaluate the profitability of its manufacturing operations, while the net profit margin helps the company evaluate the profitability of its manufacturing operations.
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