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What is gross margin?

Gross margin

What is gross margin? Gross margin definition refers to the amount of money a company has after subtracting its cost of goods or services sold (COGS) from its net sales. Net sales are gross sales, less the cost of sales returns, allowances and discounts. Sometimes referred to as the gross margin ratio, gross margin is typically expressed as a percentage.

Key takeaways:

  • Gross margin is a financial metric that measures a company's profitability by calculating the percentage of revenue that remains after deducting the cost of goods sold (COGS).
  • Gross margin is a useful indicator for assessing a company's ability to generate profit from its core operations.
  • Gross margin is typically expressed as a percentage, representing the portion of each dollar of revenue that contributes to covering operating expenses and yielding profit.
  • Higher gross margin indicates better cost control and pricing power, while lower gross margin may suggest challenges in managing production costs or competitive pricing pressures.

It typically serves as a very useful indicator of the financial performance of a business. The higher the gross margin of a company, the more capital it retains on each dollar (or pound) of sales, which it can then use to pay other costs or satisfy its debt obligations.

Where have you heard about gross margin?

Gross margin is a familiar term in business, and of great importance to every company and investor as an indicator of performance and potential.

Therefore, you may have heard about it from a variety of online and offline sources, including financial newspapers, TV news reports and the internet. Moreover, your investment manager or financial advisor may have recommended keeping your eye on a company's gross margin when making investment decisions.

What do you need to know about gross margin? 

Gross margin can be a wide-ranging business benchmark effectively used in many ways. For example, as an accounting comparison metric outside a company; a firm can measure its gross margin against industry competitors to find out how it is faring financially against its main rivals.

Generally, businesses use gross margin as a benchmark that allows them to make thoughtful and practical decisions when trying to achieve the best sales revenues to production costs ratio. For instance, if gross margin is low, a firm may choose to cut expenses in key areas like manufacturing, research, or staffing, in order to improve its financial bottom line. On the flip side, the company may decide to increase prices for its goods and services to boost its financial numbers.

Sometimes, “gross margin” can be used interchangeably with “gross profit”, however, the terms are slightly different. Gross profit refers to a monetary value, while gross margin refers to a percentage value.

The gross margin formula is as follows:

Gross margin formula

So, how to calculate gross margin in real life? Let’s take the world-renowned technology company Apple (AAPL) as an example. In 2019, the firm had total net sales of $260.17bn and its cost of goods was $162.26bn. By calculating according to the formula, the business had a gross profit of $97.91bn, or a gross margin of 37.63 per cent of net sales.

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