The gross margin is a financial ratio used to measure the financial health and efficiency of a company. It tells us how much profit a company makes after deducting the direct costs of making or purchasing the products it sells, also known as the cost of goods sold (COGS).
The gross margin is calculated by dividing the gross profit by the revenue (or sales revenue), and then multiplying the result by 100 to get a percentage. In formula form, it looks like this:
Gross Margin = (Gross Profit / Sales Revenue) x 100
The gross margin is important because it gives a company a clear picture of how efficiently it uses its resources to produce and sell products. A high gross margin indicates efficiency, as it means the company retains more profit after paying its direct production costs. A low gross margin may indicate that a company is not using its resources efficiently, or that it is selling its products at too low prices.
Imagine you run a company that sold products worth €200,000 last year and it cost you €100,000 to make those products. Your gross margin would then be calculated as follows:
Gross Margin = (€100,000 / €200,000) x 100 = 50%
This means that for every euro your company earned last year, you retained 50 cents after paying the direct costs of making your products.