Gross margin, also known as Gross Profit Margin, refers to the profit generated from sales after subtracting the cost of goods sold.
In simple words, Gross Margin is a measure to understand whether a business is operating an efficient operation, and its profits are good enough or not.
The gross margin can be a very relevant measure to understand how well a company is doing financially. It eliminates the cost or expenses of running day-to-day operations to provide you with a clear margin.
Once an organization establishes the gross margin, it should remain reasonably constant. Alterations in the manufacturing process most commonly cause variations or fluctuations in the margin (for example, changes made to the products pricing, automation of various parts of production, or regulation changes that affect production process).
Gross margin will show investors whether the company is still profitable at various levels of output or not.
Gross profit margin formula
The Gross Profit percentage provides you with an idea of how much profit earned with every pound made.
You can measure the gross profit margin (which is a percentage) using an equation that divides the Revenue less the cost of the goods sold by the total Revenue:
| Gross Profit Margin = [Revenue – Cost of Goods Sold] ÷ Revenue |
The higher your gross profit, the more influential the company is in manufacturing its products and services.
For example
Tina had just launched her business, and she made a revenue of about £155,000. However, her operating costs involve some pricey equipment and ingredients, so they cost her about £ 82,000 per year. Consequently, her gross profit margin equation will be something like this:
Gross Profit Margin = (£155,000 – £82,000) ÷ £155,000
The result will be 0.47, or a gross profit margin of 47%.
This profit margin means that she receives half of that in profit for each pound spent running her business. Tina’s gross profit is £ 69,000, which is used towards her business to meet various recurring expenses, such as promotions, utilities, rent for her shop, etc.
Pros of Profit margin
- The profit margin can help to track a company’s progress or performance over a while.
- It acts as a Benchmark as many investors and analysts use gross profit margin to measure a business’s profitability to compare it with competitors.
- It can help companies or businesses to identify areas that need improvement.
- Companies can change their pricing strategies by using profit margin as a guideline.