Gross Margin

Gross margin shows how much a company keeps from each dollar of sales after paying the direct costs of making its products or delivering its services, known as the cost of goods sold. Those costs include materials, production labor and, for many businesses, shipping or hosting.

The formula is revenue minus cost of goods sold, divided by revenue, times 100. Revenue minus cost of goods sold, in dollars, is called gross profit.

Example: a company sells $500 million worth of products that cost $300 million to make. Gross profit is $200 million, and gross margin is 40%.

A high gross margin suggests pricing power or efficient production and leaves more money to cover research, marketing and administration. Software and branded consumer goods companies often have high gross margins, while grocery chains and contract manufacturers usually have low ones. Comparisons are most useful within the same industry.

Changes in gross margin can reveal a lot. A falling margin may point to rising input costs or price competition, while a rising margin may reflect better pricing or a richer product mix.

Gross margin is the first of three common margins, followed by operating margin and net profit margin.