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What is gross margin?

Gross margin is the difference between 1) the cost to produce or purchase an item, and 2) its selling price. For example, if 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). Similarly, if a retailer has net sales of $40,000 and its cost of goods sold was $24,000, the gross margin is $16,000 or 40% of net sales ($16,000/$40,000).

It is important to realize that the gross margin (also known as gross profit) is the amount before deducting expenses such as selling, general and administrative (SG&A) and interest. In other words, there is a big difference between gross margin and profit margin (or net profit margin).