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Gross margin definition

Description

This is the most general profitability ratio. When we calculate gross profit margin we compare revenue from sold goods or services to the cost needed to produce or buy it. This ratio shows how profitable a company is at the most common level. Data to calculate this ratio is collected from the income statement.

Gross profit margin must be considered by investors and high level management. Investors use this ratio to compare companies in different industries to determine what are the most profitable. Managers mostly use it to compare companies in the same industry, because they can indicate how competitive the companies are.

Norms and limitations

The higher the gross margin value the more competitive the company is.

Most often the value of this ratio is compared to the ratio value of the competitors of the company. Wide value variations are observed from industry to industry. Gross margin is mostly expressed in percentages.

Formula

Gross profit is calculated by deducting the cost of sold goods from the net sales.

Cost of goods sold (COGS) is the cost that goes directly into creating the products that a company sells.

Net sales (revenues, sales) can be described as sales deducting returns and discount for customers.