Gross margin is a financial ratio that shows how much profit a company makes after deducting the direct costs of producing its goods or services. It is usually expressed as a percentage of revenue. Gross margin indicates how efficiently a company turns sales into gross profit.
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Gross margin reflects how much money remains to cover operating expenses and generate profit.
Gross margin is calculated by subtracting the cost of goods sold from total revenue and dividing the result by revenue. A higher gross margin means a company retains more money from each dollar of sales to pay for salaries, marketing, research, and other expenses. It is often used to compare profitability between companies within the same industry. However, gross margin does not include operating costs, taxes, or interest expenses, so it does not represent net profit. Changes in input costs, pricing strategy, or competition can directly affect the margin.
Short example:
Suppose a company generates $1,000,000 in revenue.
The direct production costs amount to $600,000.
The gross profit is $400,000, which means the gross margin is 40 percent.
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