What is gross margin?

Definition of Gross Margin
The term gross margin is often used to mean the difference between 1) the cost to produce or purchase an item, and 2) its selling price. Using this definition, gross margin is the same as gross profit.

The term gross margin is also used to mean the gross profit as a percentage of sales. When gross margin is referring to percentage, some people (but not all) will use the term gross margin ratio (or gross profit percentage).

Examples of Gross Margin
To illustrate gross margin, let's assume that a company's manufacturing cost of a product is $28 and the product is sold for $40. The product's gross margin is $12 ($40 minus $28), or 30% of the selling price ($12/$40).

If a retailer had net sales of $40,000 and its cost of goods sold was $24,000, the gross margin was $16,000 or 40% of net sales ($16,000/$40,000).

Additional Comment
It is important to realize that the gross margin (or gross profit) is the amount before deducting selling, general and administrative (SG&A) expenses and interest expense. In other words, gross margin is different from profit margin (or net profit margin).

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