Definition of Gross Margin
Gross margin as a percentage is the gross profit divided by the selling price. For example, if a product sells for $100 and its cost of goods sold is $75, the gross profit is $25 and the gross margin (gross profit as a percentage of the selling price) is 25% ($25/$100).
Example of Calculating the Markup on Cost to Earn a Specified Gross Margin
Since you know the cost of a product and you know the gross margin percentage to be achieved, you can determine the selling price and the markup needed.
Let's begin by assuming that a company's product has a cost of $75 and the company desires a 25% gross margin (or 25% of the selling price). Let's use "SP" to indicate the product's required selling price and "MU$" to represent the gross profit, and state the gross margin as 0.25SP. This means that:
- SP = Cost + MU$
- SP = $75 + MU$
- Since MU$ must be 25% of SP, we can state: SP = $75 + 0.25SP
- Restating the previous point, we have: SP - 0.25SP = $75
- Restating the previous point, we have: 0.75SP = $75
- After dividing each side of the equation by 0.75, we have: SP = $100
With a selling price of $100 and a cost of $75, the $25 markup as a percentage of the $75 cost is 33.33% ($25/$75). The gross profit of $25 ($100 - $75) also means a gross margin of 25% ($25 gross profit divided by the selling price of $100).