Gross Margin

From Financial Literacy Wiki

Gross margin, Gross profit margin or Gross Profit Rate is the difference between the sales and the production costs including the overhead. Gross margin can be defined as the amount of contribution to the business enterprise, after paying for direct-fixed and direct-variable unit costs, required to cover overheads (fixed commitments) and provide a buffer for unknown items. It expresses the relationship between gross profit and sales revenue. This is a clear calculation.

It can be expressed in absolute terms:

Gross margin = Net Sales - Cost of Sales + annual sales return

or as the ratio of gross profit to sales revenue, usually in the form of a percentage:

Gross Margin Percentage = (Revenue-Cost of Sales)/Revenue

Cost of Sales (also known as Cost of Goods (CoGs)) includes variable costs and fixed costs directly linked to the sale, such as material costs, labor, supplier profit, shipping costs, etc. It does not include indirect fixed costs like office expenses, rent, administrative costs, etc.

Higher gross margins for a manufacturer reflect greater efficiency in turning raw materials into income. For a retailer it will be their markup over wholesale. Larger gross margins are generally good for companies, with the exception of discount retailers. They need to show that operations efficiency and financing allows them to operate with tiny margins.