Definition
The financial ratio known as gross margin is a measure of a company's ability to profitably make a product or supply a service. This measure only requires two inputs found on the income statement: revenues and the cost of goods sold.
Calculation
Gross Margin = Gross Profits / Revenues
Where:
Gross Profits = Revenues - Cost of Goods Sold
Explanation
The closer the gross profit margin is to 1.0, the more efficient the operation. This is true because as the gross profit margin approaches 1.0, the cost of goods sold approaches zero. Relatively high gross margins may be an indicator of brand loyalty or a trade / manufacturing advantage.
When making benchmark comparisons, investors and analysts look for companies with relatively high gross margins. When drawing conclusions about the relative performance of a company, benchmark comparisons should be made with competitors in the same industry.
Example
Company A's balance sheet indicates revenues of $29,611,000 and a cost of revenue (another name for cost of goods sold) of $15,693,000. Company A's gross margin would be:
= ($29,611,000 - $15,693,000) / $29,611,000 = $13,918,000/ $29,611,000, or 0.47
Related Terms
The income statement is a financial accounting report that demonstrates how net income, or profit, is derived from revenues. The main categories appearing on an income statement include revenues, cost of goods sold, operating expenses, non-recurring items and net income.
Moneyzine EditorJanuary 22nd, 2024- The financial accounting term revenue is used to describe the price charged to customers for good sold, or services rendered. Revenues are reported on a company's income statement.Moneyzine EditorSeptember 21st, 2023
The direct expense a company incurs when making a product, or supplying a service, such as raw materials and labor are referred to as the cost of goods sold (COGS). Also referred to as the cost of sales, the cost of goods sold appears as a line item expense on the income statement.Moneyzine EditorJanuary 12th, 2024
The gross profit index is an operating performance measure that allows analysts to understand if the gross profit margin is changing significantly over time. When the gross profit index varies considerably from 1.0, it may indicate irregularities in the reporting of profits.Moneyzine EditorJanuary 19th, 2024
