Gross margin is the companies total revenue or total sales during a given period minus the costs for the goods sold. It shouldn’t be confused with the net margin because to calculate the net margin you will have to extract all expenses from the gross margin.
The bigger the gross margin, the more capital a business has. A big gross margin helps businesses develop, start to hire more employees and expand their business in a different area.
To calculate the gross margin you will need to subtract the costs of the goods you’ve sold from the total revenue generated by those sales. The formula for gross margin is:
Gross margin = Net Sales - COGS
Net sales are the total revenue or the total amount of income generated from sales during a period of time. It can also be called net sales because it can include discounts and deductions from returned merchandise.
COGS stand for the cost of goods sold. The direct costs associated with producing goods and selling products. It includes both direct and indirect costs for the production and distribution of the products.
Let’s take an example to better understand the formula. You have a grocery store and for a week you generate revenue of $5000 from sales. The cost of the products is $1000 and the labor cost is $1500. This means that you have a gross margin of $2500.
It depends on the industry, type of business, pricing strategy, and so on. Every business is different, from the concept to the products sold and the employees hired. This is why it is hard to say what a good gross margin is. However, the benchmarks for gross margin are:
|
Gross margin percentage |
Qualifies as |
|
<10% |
low gross margin |
|
10% |
average gross margin |
|
20% |
good gross margin |
|
>20% |
great gross margin |