Gross margin is a financial metric that represents the amount of money left over after subtracting the cost of goods sold (COGS) from total revenue. It is expressed as a percentage, and is sometimes referred to as gross profit margin.
The formula for calculating gross margin is:
Gross Margin = (Total Revenue – COGS) / Total Revenue x 100%
For example, if a company sells $1,000 worth of goods and the COGS for those goods is $600, the gross margin would be:
Gross Margin = ($1,000 – $600) / $1,000 x 100% = 40%
This means that for every dollar of revenue generated, the company is able to keep 40 cents as gross profit.
Gross margin is an important metric for businesses because it helps to indicate how efficiently they are able to produce and sell their products. A higher gross margin generally indicates that a company is able to command higher prices for its products, or that it is able to produce those products at a lower cost.
However, it is important to note that gross margin does not take into account other expenses, such as operating expenses or taxes. Therefore, it should be used in conjunction with other financial metrics, such as net income or operating margin, to get a complete picture of a company’s financial health.
Few examples of gross margin calculations:
- Retail: A retailer sells $100,000 worth of products and incurs $60,000 in COGS. The gross margin for the retailer would be ($100,000 – $60,000) / $100,000 x 100% = 40%. This means that the retailer keeps 40 cents of every dollar of revenue generated as gross profit.
- Manufacturing: A manufacturer produces and sells 1,000 units of a product for $50 each, with a total revenue of $50,000. The COGS for each unit is $25, resulting in a total COGS of $25,000. The gross margin for the manufacturer would be ($50,000 – $25,000) / $50,000 x 100% = 50%. This means that the manufacturer keeps 50 cents of every dollar of revenue generated as gross profit.
- Service industry: A software-as-a-service (SaaS) company generates $500,000 in monthly recurring revenue (MRR) and has a monthly COGS of $200,000. The gross margin for the company would be ($500,000 – $200,000) / $500,000 x 100% = 60%. This means that the SaaS company keeps 60 cents of every dollar of MRR generated as gross profit.