Gross Margin Formula

What is Gross Margin Formula?

Gross margin is derived by the deducing Cost of Goods Sold (COGS) from the Net Revenue or Net Sales (Gross Sale reduced by discounts, returns, and price adjustments), and when the result is divided by revenue, we can arrive at the gross profit percentage. The formula of gross margin in numbers and percentage term is as follows:

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For eg:
Source: Gross Margin Formula (wallstreetmojo.com)

Explanation

• Gross Sales: Revenue or sales is the amount fetched by the company after selling its services or goods. Generally, all the major companies follow the accrual method of accountingAccrual Method Of AccountingAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. read more as prescribed by GAAP (Generally Accepted Accounting PrincipleGenerally Accepted Accounting PrincipleGAAP (Generally Accepted Accounting Principles) are standardized guidelines for accounting and financial reporting.read more).
• In the accrual system, revenue or expenses are recorded as and when it takes place irrespective of whether cash has been received or not. The total receipt from selling the goods or services is known as gross revenue.
• Net Sales: To arrive at the net sales figure, few items of price adjustments, deductions, and returns need to be separated from the gross revenue. The formula for net sales is as follows:

• Cost of Goods Sold: The direct costsDirect CostsDirect costs are costs incurred by an organization while performing its core business activity and can be attributed directly in the production cost, such as raw material costs, wages paid to factory staff, power & fuel expenses in a factory, and so on, but do not include indirect costs such as advertisement costs, administrative costs, etc.read more such as raw material and labor for the units of goods sold are considered as COGS(Cost of Goods Sold). Here we do not include indirect costsIndirect CostsIndirect cost is the cost that cannot be directly attributed to the production. These are the necessary expenditures and can be fixed or variable in nature like the office expenses, administration, sales promotion expense, etc.read more such as selling and administration expenses.
• The remaining goods, whether in the finished or unfished condition, is called inventory. So, we take the opening inventory (closing inventoryClosing InventoryClosing stock or inventory is the amount that a company still has on its hand at the end of a financial period. It may include products getting processed or are produced but not sold. Raw materials, work in progress, and final goods are all included on a broad level.read more of the previous year), add purchases and other direct expenses, and deduct the closing inventory (stock of unsold products). It is calculated as follows:

Steps to Calculate Gross Margin

Examples of Gross Margin Formula(with Excel Template)

Let’s see some simple to advanced examples of the gross margin equation to understand it better.

Gross Margin Formula Example #1

Let’s take the example of Apple Inc. as on September 28, 2019. The company has sold products and services worth $213,833 million and $46,291 million, respectively. The cost of goods sold includes the Cost allocated to products and services amounting to $144,996 million and $16786 million each. Find out the Gross Margin and Gross Margin percentage.

Solution:

Use the below-given data for the calculation of gross margin.

Calculation of Gross margin can be done as follows:

Gross Margin = $260174 – $161782

The gross margin will be –

Gross Margin = $98,392

Calculation of Gross margin % can be done as follows:

Gross Margin (%) = ($260174 – $161782 ) * 100% / $260174

Gross Margin (%) will be –

Gross Margin (%) = 38%

Explanation 

The gross margin equation expresses the percentage of gross profitPercentage Of Gross ProfitGross profit percentage is used by the management, investors, and financial analysts to know the economic health and profitability of the company after accounting for the cost of sales. Gross profit percentage formula = Gross profit / Total sales * 100% read more; the company is earning from $1 of sales. In the above case, Apple Inc. has arrived at a gross margin of $ 98,392, and 38% as in percentage form. This 38% of gross margin indicates that out of 1$ of revenue from the net sales, Apple Inc. is able to make a gross profit of 0.38 cents.

Gross Margin Formula Example #2

Let’s also take one more example. We have data from Microsoft Inc. For the year ended June 30, Microsoft had a Revenue from products and services and another dept. of $ 66,069 million and $59,774 million, respectively. Also, In the same period, The Cost of RevenueCost Of RevenueThe cost of revenue is the total expense incurred from manufacturing to delivering a product or service to the customer. It reflects all direct costs associated with the product or service delivered and is reflected in a company's income statements.read more for Product and Service and another dept. is $16273 million and $26,637 million, respectively. We will try to calculate Gross Profit MarginGross Profit MarginGross Profit Margin is the ratio that calculates the profitability of the company after deducting the direct cost of goods sold from the revenue and is expressed as a percentage of sales. It doesn’t include any other expenses into account except the cost of goods sold.read more from the above-mentioned data.

Solution:

Use the below-given data for the calculation of gross margin.

Calculation of gross margin in excel can be done as follows:

Gross Margin = $125843 – $42910

Gross Margin will be –

Gross Margin = $ 82,933.

Calculation of gross margin (%) can be done as follows:

Gross Margin (%) = ($125843 – $42910) * 100 % / $125843

Gross Margin (%) will be –

Gross Margin (%) = 66%

Explanation

As we can see, Microsoft has clocked the Gross margin to the tune of $ 82,933 million and 66% in terms of percentage. As Microsoft Inc. and Apple Inc. are in similar fields, we would be able to compare these companies. In the absolute term, Apple Inc. has a Gross Margin of $ 98,392 million, whereas Microsoft has earned only $ 82933 million. But, when it comes to the percentage figures, Microsoft Inc. has a superior margin at 66% in comparison to 38% of Apple Inc.

Relevance and Uses of Gross Margin Formula

Gross margin plays an important role in the evaluation of the company for various purposes. Few noted ones are mentioned below:

• It is an important indicator of judging the ability of the entity to clocking profits from its core operations. At this stage, the Gross profit margin only includes the operating revenueOperating RevenueOperating revenue is defined as revenue earned by an individual, corporation, or organization from the core activities that they undertake on a regular basis. There are several methods to earn revenue, but operational revenue is earned by the core business activities that the organization undertakes in its daily operations.read more and expenses. Hence, the company’s fundamental strength is being observed by this ratio. The higher ratio reflects the robust strength of the company to make profits.
• The main constituents of the Gross Margin Ratio are the operating revenue and expenses. These two heads are vital to the business and help the management to oversee the performance of the production and sales division.
• If the Gross margin ratio is falling, the unproductive department could be easily tracked down and work upon. Multiple measures could be taken to increase the productivity of that particular department. On the other hand, if the decline in the ratio has been caused by the revenue’s side, problems in the sales and distribution department should be taken into consideration.
• The gross profit ratioGross Profit RatioThe gross profit ratio evaluates the proportion of the direct profit a company generates from its net sales. Here, the gross profit is the returns acquired after considering the cost of goods sold, trade discounts and sales returns for deduction from the total revenue.read more is also known as the Contribution from the sales. The contribution from sales helps the business be on track. If we want to accumulate a profit of $500 and we earn a contribution of $5 per unit, we require to sell at least 100 units to meet our target. If there is not enough market for 100 units, then either we need to decrease the production cost or increase the sales price.
• By comparing the Gross Margin ratio of various companies in the same industry or similar business environments, we could easily assess the superiority or inferiority of the respective company in relation to its peers. So, it turns out to be one of the primary factors to be checked when a better player from the same industry needs to be picked.

Recommended Articles

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