What is Gross Margin?
Introduction
Gross margin is a key financial metric that measures how much a company earns after subtracting the cost of goods sold (COGS) from total revenue. It indicates how efficiently a business produces and sells its products.
Gross Margin Formula
Gross Margin = ((Revenue - COGS) / Revenue) × 100
- Revenue: Total sales of goods or services.
- COGS (Cost of Goods Sold): Direct costs of producing goods (materials, labor, manufacturing costs).
Example Calculation
Imagine a company sells furniture and has the following financials:
- Total Revenue = ₹10,00,000
- COGS (raw materials, labor) = ₹6,00,000
Gross Margin = ((10,00,000 - 6,00,000) / 10,00,000) × 100 = 40%
This means the company keeps 40% of its revenue after covering direct production costs.
Why Gross Margin Matters
- Profitability Indicator – Shows how well a company controls production costs.
- Better Pricing Strategies – Helps businesses set prices for profitability.
- Investor Confidence – Investors analyze gross margin to evaluate financial health.
Gross Margin vs. Net Margin
| Metric | Definition | Formula | Includes |
|---|---|---|---|
| Gross Margin | Profitability after direct costs | (Revenue - COGS) / Revenue | Direct costs (materials, labor) |
| Net Margin | Profitability after all expenses | (Net Profit / Revenue) | Direct + indirect costs (taxes, rent, salaries) |
Conclusion
A higher gross margin means a company is efficiently producing goods while keeping costs under control. Businesses should monitor and improve their gross margin to increase profitability and competitiveness.