A Quick Performance Gauge
Gross margin is gross profit expressed in terms of percentage or ratio. The percentage is applied to determine how much of the money generated by the business activity is available for operating expenses, interest expenses, and, ideally, returns on stockholders’ investments.
In knowing how to compute the gross margin, the business owner will have a quick reference for gauging business performance in real time. This way, he can institute measures to increase sales or to control overhead costs at the earliest time possible.
The gross profit margin formula in order to arrive at the percentage is as follows:
Gross Margin = (Gross Revenue – Cost of Goods Sold) / Gross Revenue
To illustrate as example, consider the following givens: Gross Revenue (GR): $50,000; Cost of Goods Sold (COGS): $10,000
Gross Margin = ($50,000 - $10,000)/$50,000
= $0.80 or 80%
This means, for every dollar of the $50,000 gross revenue earned, $0.80 can be used to pay for operating expenses and partly for distribution of returns on stockholders’ investments. The $40,000 amount in this quick computation is aptly called the Gross Profit when presented in the Income Statement.