Gross margin — definition and purpose Gross margin (or gross profit margin) is the percentage of revenue a company retains after covering the direct costs of producing its goods or services. It measures how efficiently a business converts sales into gross profit before accounting for operating expenses, interest, and taxes. Key points:
Shows the portion of each dollar of revenue remaining after cost of goods sold (COGS).
Useful for assessing production efficiency and pricing strategy.
* Helps investors and managers compare profitability across companies or time periods. Explore More Resources
Formula and calculation Gross margin (%) = (Gross profit ÷ Net sales) × 100 Where:
Gross profit = Net sales − Cost of goods sold (COGS)
Net sales = Total revenue after discounts and returns
* COGS = Direct costs of production (materials, direct labor, manufacturing supplies) Explore More Resources
Example:
Revenue: $200,000
COGS: $100,000
Gross profit = $200,000 − $100,000 = $100,000
Gross margin = ($100,000 ÷ $200,000) × 100 = 50% What gross margin tells you Gross margin indicates how much money is available from sales to cover operating expenses, interest, taxes, and profit distributions after direct production costs are paid. A higher gross margin means more funds remain per dollar of revenue to support the rest of the business. Explore More Resources
Actions companies might take when margin falls:
Reduce direct labor or find cheaper suppliers
Improve production efficiency
Increase product prices (if market allows) Gross margin also supports comparisons:
Across time to monitor trends in production efficiency
* Between competitors or industry peers to evaluate relative cost structures Explore More Resources
Gross margin vs. net margin
* Gross margin focuses only on revenue and COGS (production-related costs).
* Net margin (net profit margin) accounts for all expenses, including operating expenses, interest, taxes, and non-operating items.
Use gross margin to assess production profitability; use net margin to assess overall business profitability.
Gross margin vs. gross profit
* Gross profit is a dollar amount: revenue minus COGS.
* Gross margin is that gross profit expressed as a percentage of revenue.
Both draw from the same inputs but serve different reporting and comparison purposes.
What is a good gross margin? There is no universal “good” margin—acceptable levels vary widely by industry:
Service-based businesses typically have higher gross margins because they have lower COGS.
Manufacturing and retail often have lower gross margins due to significant material and production costs.
Compare a company’s gross margin to industry peers and historical performance to judge acceptability. Conclusion Gross margin is a core profitability metric that reveals how effectively a company turns revenue into gross profit after direct production costs. It’s essential for internal cost management, pricing decisions, and investor evaluation, but should be interpreted in context with industry norms and other profitability measures such as net margin. Explore More Resources