Definition of Gross Margin
Gross margin is the amount remaining after a retailer or manufacturer subtracts its cost of goods sold from its net sales. In other words, gross margin is the retailer’s or manufacturer’s profit before subtracting its selling, general and administrative, and interest expenses.
Gross Margin Can be an Amount or a Percentage
Gross margin could be expressed as:
- An amount (also known as gross profit)
- A percentage of net sales (also known as gross profit percentage or gross margin ratio)
The gross margin may be calculated for an individual product, a product line, or for the entire company.
Examples of Gross Margin Calculations
If a retailer had net sales of $40,000 and its cost of goods sold was $24,000, the retailer had a gross margin of $16,000 or 40% of net sales ($16,000/$40,000).
A manufacturer sells a product for $40 and its cost of goods sold (which consists of its manufacturing costs) is $28. Therefore, the product’s gross margin is $12 ($40 minus $28), or 30% of the selling price ($12/$40).
Difference Between Gross Margin and Profit Margin
Gross margin is the amount or percent before subtracting the selling, general and administrative, and interest expenses. Profit margin is the amount or percent after the selling, general and administrative, and interest expenses are subtracted. For example, a chain of grocery stores many have a gross margin of 20%, but its profit margin may be 1% (of net sales).
What the Gross Margin Tells You
Analysts track a company’s gross margin percentage to determine whether the company is able to increase selling prices when costs are increasing or when competitors are reducing prices or expanding their sales efforts. The gross margin of individual products could indicate to management that some products should be promoted more aggressively and some products should be phased out.
