What is Gross Margin? Definition and How to Calculate
Gross Margin definition in accounting. Learn the formula for gross margin, see a calculation example, and understand why gross margin is key to profitability.
What is Gross Margin?
Gross margin in accounting represents the difference between a company’s revenue and the cost of goods sold (COGS).
It shows how much of each dollar earned is retained as gross profit before deducting operating expenses, taxes, or interest.
In simpler terms, it’s a measure of how efficiently a business produces and sells its products relative to the costs involved.
What is Gross Profit Margin?
Gross profit margin is the percentage of revenue that remains after subtracting COGS, indicating the profitability of core business operations.
A higher gross profit margin means the company retains more profit from each sale, which can then contribute to covering other expenses and generating net profit.
The terms gross margin and gross profit margin are often used interchangeably in financial discussions.
How to Calculate Gross Margin
To calculate gross margin, you subtract the cost of goods sold from total revenue.
This gives the gross profit, which can then be expressed as a percentage of revenue to determine the gross profit margin. Understanding how to calculate margin is essential for assessing a company’s financial health and comparing profitability across different periods or competitors.
Gross Margin Formula
The gross margin formula can be expressed in two ways depending on whether you want the result in dollars or as a percentage.
1. Gross margin in dollars:
This shows the actual profit made from sales before other expenses.
Formula:
Gross Margin (dollars) = Revenue - Cost of Goods Sold (COGS)
Using this formula gives you the gross profit in dollars, representing how much money is left from sales after covering the cost of goods sold.
2. Gross margin as a percentage (how to get gross margin ratio):
This expresses gross profit as a percentage of revenue, helping you see what portion of sales revenue is retained as profit.
Formula:
Gross Margin (%) = (Revenue - Cost of Goods Sold) / Revenue × 100
This can be called the gross profit margin formula or the gross margin ratio and is a key metric for analyzing profitability, comparing performance across periods, and evaluating efficiency.
By understanding both versions, you can calculate gross profit in dollars to see total profit or gross margin percentage to assess profitability relative to revenue.
Example of Gross Margin
A company reports:
- Revenue: €500,000
- COGS: €300,000
Gross Margin = (500,000 – 300,000) ÷ 500,000 × 100 = 40%
This means the company earns €0.40 for every €1 of sales after covering direct production costs.
