Gross margin is a financial metric that measures the profitability of a company's core operations by evaluating the percentage of revenue remaining after deducting the cost of goods sold (COGS). It represents the proportion of revenue available to cover other operating expenses and contribute to net profit.
The formula for calculating gross margin is:
Gross Margin = (Revenue - Cost of Goods Sold) / Revenue
Here's a breakdown of the components involved:
- Revenue: Revenue, also known as sales or turnover, is the total amount of money generated from the sale of products or services.
- Cost of Goods Sold (COGS): COGS refers to the direct costs associated with producing or delivering the goods or services sold. It includes expenses such as the cost of raw materials, direct labor costs, and direct production costs. COGS excludes other operating expenses, such as marketing, administrative costs, and overhead expenses.
By subtracting the COGS from the revenue and dividing it by revenue, the gross margin is expressed as a percentage. It indicates the portion of each dollar of revenue that remains as gross profit. In other words, gross margin shows how much profit a company generates from its core operations relative to its revenue.
A higher gross margin generally indicates better profitability, as it suggests that a company is able to generate a larger profit margin from its products or services. It can be influenced by factors such as pricing strategy, production efficiency, economies of scale, and the cost of raw materials.
Gross margin is a key indicator used by investors, analysts, and management to assess a company's profitability and compare it with industry peers. It provides insights into the company's ability to effectively manage costs and generate profits from its primary business activities.