Gross margin is a key financial metric representing the percentage of revenue that exceeds the cost of goods sold (COGS). In simpler terms, it shows how much money a company retains from revenue after covering direct production costs. As an essential profitability measure, it reveals the operational efficiency and pricing power of a business.
Calculating gross margin is straightforward. It involves subtracting the cost of goods sold from total revenue, dividing this number by total revenue, and multiplying by 100 to obtain a percentage:
Gross Margin (%) = (Revenue - Cost of Goods Sold) ÷ Revenue × 100
Businesses closely monitor gross margin because it provides insights into their ability to manage costs effectively and set appropriate prices. A consistently high gross margin indicates a strong competitive advantage, potentially stemming from efficient processes, strong brand positioning, or successful cost-control strategies. Conversely, a low or declining gross margin might signal issues like rising raw material costs or pricing pressures from competition, prompting companies to investigate further and adjust strategies.
Regularly tracking gross margin helps businesses maintain financial health, informing strategic decisions on pricing, suppliers, and overall cost management to ensure long-term profitability and sustainable growth.
