Gross margin is a company’s net sales revenue minus its cost of goods sold (COGS). In other words, it is the sales revenue a company retains after incurring the direct costs associated with producing the goods it sells, and the services it provides. The higher the gross margin, the more capital a company retains on each rupee of sales, which it can then use to pay other costs or satisfy debt obligations. The net sales figure is simply gross revenue, less the returns, allowances, and discounts.
The formula of Gross Margin= Net sales- COGS(cost of goods sold)
Companies use gross margin to measure how their production costs relate to their revenues. For example, if a company’s gross margin is falling, it may strive to slash labor costs or source cheaper suppliers of materials. Alternatively, it may decide to increase prices, as a revenue increasing measure. Gross profit margins can also be used to measure company efficiency or to compare two companies of different market capitalizations.
Difference between Gross Profit and Net Profit- While gross margin focuses solely on the relationship between revenue and COGS, the net profit margin takes all of a business’s expenses into account. When calculating net profit margins, businesses subtract their COGS, as well as ancillary expenses such as product distribution, miscellaneous operating expenses, and taxes.
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