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What is gross margin?

Understanding capital gross margin and how it works.

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What is gross margin?

Gross profit margin, also known as gross margin, is a financial metric used to measure just how effective and efficient a business is at managing its operations. The gross margin is the sales revenue that a company retains after incurring the direct costs that are associated with producing the goods it sells and services it provides.

Gross margin helps to indicate the performance of a company’s sales based on the efficiency of its production process. The financial ratio is used by managers to assess and determine the efficiency of the production process for a product or service sold by the company, and is based on the company’s cost of goods sold.

Key points about gross margin
    • Gross margin is a valuable financial measurement that helps to indicate the efficiency with which the business can produce and sell their products or services.
    • Gross margin is based on the company’s cost of goods sold – the direct costs of producing the company’s products or services.
    • The gross profit margin is a measurement that is highly valued by managers and also potential investors of a company as it is an accurate way of calculating business efficiency.
    • The gross margin shows the amount of profit made before deducting selling, general and any admin costs.

How does gross margin work?

The formula for calculating gross margin is as follows:

Gross margin = (Net Sales – Cost of Goods Sold) / Net Sales

This formula will give a percentage which is the company’s gross profit margin.

The calculation for gross margin contains only two variables: net sales and cost of goods sold, both of which can be found on the company’s bank statement.

Net sales is used instead of total revenue as total revenue would not give an accurate answer if used in the above equation, as it does not subtract any returns, discounts or allowances from the total amount of sales.

Cost of goods is the sum of the overall production costs of a company’s product, and includes both direct labour costs and also any costs of the materials and resources used in the production and manufacturing of a company’s products.

What is the difference between gross margin and net margin?

Gross margin and net margin are both profitability ratios that are used to assess the overall financial wellbeing of a company. They are both expressed in percentage terms and are a way of measuring profitability as compared to revenue for a specific period.

Gross margin is the amount and proportion of money that is left over from revenues after accounting for the overall cost of goods that were sold. Net margin is the percentage of net income that is generated from a company’s revenue and is often referred to as the bottom line for a company, or the net profit.

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Gross Margin FAQs

What exactly is gross margin?

Gross margin is a company’s net sales revenue minus the cost of goods that are sold. In other words, it measures the actual sales revenue retained by a company after incurring any direct costs that are associated with producing the goods that it sells and the services it provides.

How do you calculate gross margin?

The formula for calculating gross margin is Gross Margin = Net Sales – COGS.

Net sales is equivalent to the total amount of money that is generated from sales for the specific time period and includes all discounts and deductions from returned merchandise.

COGS is the cost of goods sold and includes both direct labour costs and also any costs of materials that were used in the production of the company’s products.

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