Gross margin, also known as gross profit margin, is a financial term used to indicate the percentage of sales revenue a company retains after incurring the direct costs associated with manufacturing the goods it sells, or providing its services. You calculate it by subtracting the cost of goods sold (COGS) from total sales revenue and then dividing that number by total sales revenue. The result is then multiplied by 100 to get the percentage. It’s a measure of a company’s overall operating efficiency and its financial health.
Related Questions
1. What’s the difference between gross margin and profit margin?
Gross margin measures the profitability of the product/service itself, ignoring overhead like operating expenses, taxes, or interest payments. Profit margin, on the other hand, factors in those costs, showing the portion of each dollar of revenue that’s net income.
2. Why is gross margin important for a business?
Want More Financial Tips?
Gross margin is important because it reflects the core profitability of a company before overhead costs, and it’s a measure used widely to compare the profitability of companies and industries.
3. How can a business improve its gross margin?
A business can improve its gross margin by increasing prices, decreasing costs of production, or selling more of high-margin items.
4. Can a company have a negative gross margin?
Yes, a negative gross margin means the cost of goods sold exceeds revenue. This situation typically arises in scenarios where a company’s production costs are higher than the price at which its products are being sold.
5. Is a higher gross margin always better?
Generally, a higher gross margin is better as it indicates that the company is generating more profit for each dollar of sales. However, a high gross margin doesn’t always mean overall profitability, as it doesn’t factor in operating expenses, taxes, or interest payments.