Gross Margin Definition
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Gross Margin Accounting Concept Around Profitability
The definition of gross margin is the profitability of a business after subtracting the cost of goods sold from the revenue.
It is a reflection of the amount of money a company retains for every incremental dollar earned.
For example, say a company has a revenue of $1 million. The cost of goods sold, including materials and labor, totals $250,000.
The company therefore has a gross profit of $750,000.
This means they retained $0.75 in gross profit per dollar of revenue, for a gross margin of 75%.
To define gross margin in simpler terms, it is simply gross profit, stated as a percentage of the revenue.
What is a Gross Margin?
Gross margin provides a helpful way for businesses to track production efficiency over time.
For example, if the gross margin is decreasing, it could mean the cost of production has grown, or the company has offered more discounts recently.
To raise gross margin, the business can cut labor costs, source cheaper materials, offer less discounts, or raise their prices.
What Does Gross Margin Mean?
Gross margin differs from other metrics like net profit margin because it exclusively considers the costs directly tied to production.
Since the cost of producing goods is an inevitable expense, some investors view gross margin as a measure of a company’s overall ability to generate profit.
The margin remaining after subtracting the cost of goods sold is used to pay for all other expenses, and if the company is profitable, the money left over is known as “net profit.”