How to Calculate Gross Margin
Gross margin or “gross profit margin” is defined as the total revenue from sales for the company less its cost of goods sold, divided by total revenue from sales. Gross margin, then, represents the relationship between the company’s gross profit and its revenue from sales. The higher a company’s gross margin, the more it keeps from each dollar of sales, so most companies seek as high a gross margin as possible. High gross margins for a manufacturer, for example, demonstrate efficiency in converting raw materials into earnings. Discount retailers are an exception to the rule when it comes to gross margin as they need to demonstrate that efficient operations enable them to operate with minimal margins.
Calculate Gross Margin
Gross margin is expressed as a percentage and the formula can be written as:
Gross Margin = (Revenue – Cost of Goods Sold) / Revenue
As an example, a company that shows a gross margin of 20% would retain $.20 from every dollar of revenue it generates. This money can, of course, be applied to such things as expenses and distributions to its shareholders in the form of dividends.
A company that can demonstrate higher gross margin than its competitors is seen as more efficient and is more likely to attract investors as most are willing to pay more for a business that can show a superior ability to manage costs and resources.
Gross margin levels tend to vary by industry as less capital-intensive business typically demonstrate high gross margin than businesses that require higher levels of infrastructure.
It is also worth noting that, for most companies, their gross margin tends to not change very much over time. In fact, dramatic changes in gross margin could trigger suspicion of fraudulent accounting practices.
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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