Gross margin is a ratio that shows what percentage of the revenue a company retains after it excludes all the costs that are directly associated with producing its products or services. In other words the gross margin reveals how much a company earns taking into consideration the costs that it incurs directly for producing its products or services. It’s an indicators that shows how efficient a business is at using its resources and controlling its costs of production. It’s calculated as a ratio of the company gross profit, calculated as revenue less cost of sales and dividing it by the revenue. Gross margin is usually expressed as a percentage.
Gross margin ratio is calculated as the difference between revenue and cost of goods sold (COGS) divided by revenue. The formula is:
Gross Margin (%) = (Revenue – Cost of goods sold) / Revenue
The revenue and the cost of goods sold can be found on the income statement. The (revenue - costs of goods sold) number is also know as gross profit. The cost of sales (also known as cost of goods sold or COGS) includes variable costs and fixed costs directly linked to the sale, such as raw material costs, labor costs, supplier expenses, shipping-in costs, etc. However it does not include indirect fixed costs like office expenses and rent, administrative costs, etc.
Since gross margin is a way to measure company profitability and efficiency, the higher the gross margin number, the better. Higher gross margin shows the larger the capital a company can potentially retains on each dollar of revenue, which it can then be used to pay other costs, invest in growth or pay down debt obligations.
When analysing company gross margin we have to be aware that there are large differences from industry to industry and the compartment should always be benchmarked to the industry average that a particular business belongs to.
|ZEN Zendesk Inc||79.9%||$9.42B||Software - Application|
|ATEN A10 Networks Inc||79.9%||$1.02B||Software - Infrastructure|
|EYPT EyePoint Pharmaceuticals Inc||79.8%||$251.79M||Biotechnology|
|BVH Bluegreen Vacations Holding Corp||79.8%||$315.52M||Resorts & Casinos|
|NTNX Nutanix Inc||79.7%||$4.79B||Software - Infrastructure|
|WING Wingstop Inc||79.7%||$3.77B||Restaurants|
|OFS OFS Capital Corp||79.7%||$104.75M||Asset Management|
Gross margin measures a company’s manufacturing and distribution efficiency during the production process and the ability of the company to control its costs. Investors use the gross profit margin to compare companies in the same industry to determine how efficiently a particular business is run and what are the most profitable companies in a particular industry.