Gross Margin

Gross margin is the percentage of a company's revenue that it retains after direct expenses, such as labor and materials, have been subtracted. Gross margin is an important profitability measure that looks at a company's gross profit compared to its revenue.

The higher the gross margin, the more revenue a company retains, which it can then use to pay other costs or satisfy debt obligations.

Formula and Calculation of Gross Margin

Gross Margin = Net Sales − COGS

where:

• Net Sales is equivalent to revenue, or the total amount of money generated from sales for the period. It can also be called net sales because it can include discounts and deductions from returned merchandise. Revenue is typically called the top line because it sits on top of the income statement. Costs are subtracted from revenue to calculate net income or the bottom line.

• COGS is cost of goods sold. The direct costs associated with producing goods. Includes both direct labor costs, and any costs of materials used in producing or manufacturing a company’s products.

A company's gross margin is the percentage of revenue after COGS. It is calculated by dividing a company's gross profit by its sales. Remember, gross profit is a company's revenue less the cost of goods sold. For example, if a company retains $0.35 from each dollar of revenue generated, this means its gross margin is 35%.

Because COGS have already been taken into account, those remaining funds may consequently be channeled toward paying debts, general and administrative expenses, interest fees, and dividend distributions to shareholders.

Source: Investopedia, Gross Margin: Definition, Example, Formula, and How to Calculate, accessed 25 April 2024, <https://www.investopedia.com/terms/g/grossmargin.asp>