DEFINITION of gross margin
Gross margin is a required income statement entry that reflects total revenue minus cost of goods sold.
WHAT IT IS IN ESSENCE
Gross margin represents the difference between
1) the cost to produce or purchase an item, and
2) its selling price.
It is the difference between revenue and cost of goods sold (COGS) divided by revenue. It is expressed as a percentage. And calculated as the selling price of an item, less the cost of goods sold.
Companies with higher gross profit margins have a competitive edge over rivals. Whether because they can charge a higher price for goods or because they pay less for direct costs.
Therefore no company, not even a non-profit, can afford to have 0 gross margins. Or they will go out of business.
For instance, production or acquisition costs, not including indirect fixed costs like office expenses, rent, or administrative costs.
This is one of those tricky terms defined differently by every business.
But at a basic level, “gross profit” is the money earned from a sale minus the direct costs of that sale. And it is gross profit expressed as a percentage of sales.
However; some people prefer to use gross margin to mean gross profit. It is expressed as $ or %.
HOW TO USE
Here is an example of calculation.
If a company’s manufacturing cost of a product is $28 and the product is sold for $40, the product’s gross margin is $12 ($40 minus $28), or 30% of the selling price ($12/$40).
Similarly, if a retailer has net sales of $40,000 and its cost of goods sold was $24,000, the gross margin is $16,000 or 40% of net sales ($16,000/$40,000).
It is important to realize that the gross margin is the amount before deducting expenses such as selling, general and administrative and interest.
In other words, there is a big difference between gross margin and profit margin.