What is a Gross Margin?

Gross margin refers to a financial measure that depicts the percentage of income left after accounting for the direct expenses incurred in creating the product or service sold by the entity. The percentage is derived from total revenues generated, and it helps a company know how effectively it can create profit from its core operations.

Simply put, the gross margin indicates the amount of money that a company makes from every dollar of revenue generated.

How is Gross Margin Calculated?

The Gross Margin formula is:

Two things to know upfront:

• Revenue: total sales made in the period
• COGS: the cost directly associated with making the products or rendering the services being sold (cost of materials, labor, manufacturing overheads, software hosting, etc.)

Revenue minus COGS is the gross profit (in dollars). Gross profit divided by revenue equals gross margin (percentage).

Here is the practical example. 

A company brings in $500,000 in revenue and spends $200,000 on COGS.

• Gross profit = $500,000 − $200,000 = $300,000
• Gross margin = $300,000 ÷ $500,000 = 60%

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