## Definition of Gross Margin

Some use the term *gross margin* to mean the same as *gross profit*, which is: *net sales* minus the *cost of goods sold*. Others use the term *gross margin* to indicate the gross profit as a percentage of net sales.

The cost of goods sold will consist of both fixed and variable product costs. However, selling, general and administrative expenses (SG&A) are *not* part of the cost of goods sold.

## Definition of Contribution Margin

*Contribution margin* is defined as *net sales* minus both the *variable product costs* and the *variable SG&A expenses*. The contribution margin can also be expressed as a percentage of net sales. In that case it is often described as the *contribution margin ratio*.

## Information for Examples

Let's assume that a company had the following amounts during the past year:

- Net sales of $600,000
- Cost of goods sold of $320,000 ($120,000 variable + $200,000 of fixed)
- Inventories did not increase or decrease
- SG&A expenses of $190,000 ($40,000 variable + $150,000 fixed)

## Example of Gross Margin

The company's gross margin is: net sales of $600,000 minus the cost of goods sold of $320,000 = $280,000. The gross margin or gross profit percentage is: gross profit of $280,000 divided by net sales of $600,000 = 46.7%.

## Example of Contribution Margin

The company's contribution margin is: net sales of $600,000 minus the variable product costs of $120,000 and the variable expenses of $40,000 = $440,000. The contribution margin ratio is 73.3% ($440,000 divided by $600,000).