The difference between the cost of goods sold (COGS) and total sales revenue divided by the revenue gives us the Gross Margin.
Here COGS encompasses all the expenses of labor, the material used, manufacturing expenses and other production costs. Although, COGS has very different set of meaning depending upon the nature of the business. In a retail business, COGS refers to the cost of inventories while in a manufacturing sector it is inclusive of cost of labor and raw materials.
The ratio is the representation of the efficiency of management. The term is used interchangeably with Gross Profit; however, there stands a boundary of a slight difference in their meanings. To assess, any upgrade in business value, as well as economic efficiency, analysis of Gross Margin, is the straight path. For any enterprise, the difference between its financial output and its variable costs gives Gross Margin.
The main purpose that Gross Margin serves in a company is the measurement of their production cost in relation to their revenues. In case of reduction of Gross Margin, the company needs to search for a way to increase it. It may come through cutting off few supplies and deduction of the manual work which is dispensable. Also, there is always an alternative to increasing the price to upgrade the revenues. Another service that Gross Margin provides to any business is the forecast of how much the company is left with to invest in. it helps in determining the value of sales. Gross Margin indicates profit if its value increases.
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A crash in the value of Gross Margin is a threat to company’s stability which further puts a negative pressure on earnings and sales. This metrics is beyond the numeric representation of profit and expense. It helps the firm or company delineate the plan for using the money available. It administers the range to what extent a company can spend on expenditures and marketing. Apart from regulating one’s own expenses, Gross Margin helps us do a comparative analysis of other company’s Gross Margin percentage in the market. Depending upon whether the Gross Margin percentage is lower or higher one can change the pricing of their own products and goods. Ultimately Gross Margin is another way to check the future commitments in terms of marketing and advertisement. It is a figurative value of how much a company can afford. The term is often confused with Net Margin which indicates the amount left after deduction of expenses and operating costs while Gross Margin is recorded before any of these amounts are included
How to calculate Gross Margin?
Suppose a company makes a net profit of $3 million and the cost of goods sold(net sales) is $1.2 million then the Gross margin we obtain is of $1.8 million. But to be more appropriate with Gross Margin of a company or firm, it is better to express it in percentage. It helps better while comparing two different companies of different sizes. To calculate Gross Margin Percentage, divide the difference between net sales and multiply it with 100. In our case, the Gross Margin Percentage will be 150 %.