What is Gross margin?
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In short
The share of revenue left after the cost of goods sold. 60% means $60 of gross profit from every $100 of sales.
Also known as: gross profit
Gross margin shows how profitable a company's product or service is on its own. It is calculated from revenue after subtracting only the direct cost of what was sold (materials, production, server costs, delivery) — salaries, marketing and tax are not yet counted.
Formula
- Gross profit = Revenue − Cost of goods sold (COGS)
- Gross margin = Gross profit ÷ Revenue × 100%
Why it matters
A high gross margin signals pricing power: the product sells for much more than it costs to make. That money then funds research, marketing and expansion. If the margin falls year after year, competition may have intensified, input costs may have risen, or the company may be forced into discounting.
Limitations
Compare gross margin only within one industry: 70–80% is normal for a software company, while 25% can be a good result for a grocery chain. A company can have a high gross margin and still lose money — so read it together with operating margin and net margin.
Of every $100 in sales, $20 is left after costs, expenses and tax. The higher the margin, the more efficient the business.
Example
Say a fictional company reports for the year:
- Revenue: $500M
- Cost of goods sold: $200M
- Gross profit: $500M − $200M = $300M
- Gross margin: $300M ÷ $500M = 60%
So every $100 of sales leaves $60 of gross profit. If next year revenue grows to $600M while COGS rises to $270M, gross profit is $330M and the margin is $330 ÷ $600 = 55%. Sales grew 20%, but each dollar of sales now earns less — a sign worth questioning.
Mistakes and tips
Look at the trend over at least 8–12 quarters, not a single quarter: a stable or rising margin matters more than one high number.
Don't compare different industries by gross margin — retail and software have completely different economics.
If revenue grows fast while the margin shrinks, the company may be "buying" growth with discounts.
Take the figures from the income statement in the 10-K and 10-Q filings.
Frequently asked questions
- What is a good gross margin?
- There is no universal number — compare with the industry average. Above 70% is typical in software, 25–35% in retail.
- What is the difference between gross margin and net margin?
- Gross margin subtracts only the cost of goods sold, while net margin is the result after all expenses, interest and tax. Net margin is always lower than gross margin.
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