What is gross margin?

The concept of gross margin refers to the direct benefit that a company obtains from a service or good. To calculate it, the difference between the sale price of the item excluding VAT and the production cost must be taken into account. This term is also known as profit margin. It is generally calculated as a percentage of the total sales of the business.

The gross margin is the direct profit from the company's activity, without discounting impuestos, personnel expenses and others costes. The interpretation of the gross margin on sales is very important, since thanks to it, businesses will be able to determine if they are profitable or not. In the event that the gross margin is negative, this will mean that it is impossible to cover all other expenses. Hence, it also receives the name of gross profit.

What is gross margin for?

This term, gross margin, is a good gauge of the state of the business. If we are able to compare it with other similar businesses, we will know if we are working on the correct line based on the benefits of other companies in the sector.

An example of gross margin could be understood in the situation of a company dedicated to the manufacture of clothing that generates sales income of 1.000 euros and the production involves an expense of 600 euros. In this way, the gross margin would amount to 400 euros. For every euro of sale it generates 40 cents.

How to calculate gross margin?

When making investment decisions, gross margin is used as an analysis method alongside the solvency ratio or discounted cash flows.

There are three gross margin formulas to help you understand this concept a little more thoroughly:

  • Gross margin formula = Sales - Cost of goods sold
  • Gross margin percentage formula -% Gross margin = (Sales - Cost of sales) / Sales
  • Unit gross margin formula = Selling price - Item unit cost

The latter case would imply subtracting the sale price of the item less the cost of producing it.

Calculator for profit margin

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