Definition

Gross margin is the accounting and financial term. It is calculated from revenue less the cost of goods sold. It indicates that how much money is made from the goods and services before the subtraction of any administration, selling and operating expenses. It varies industry to industry.

Explanation

The gross margin amount dictates that the funds available which will be utilized to pay for selling and administrative expenses, financing costs and also for making profit. It is the key component in the budgeting and planning process. It helps to determine the amount of expenditures that can be made in these additional expenditure classifications.

Formula

The formula of it, is net sales minus cost of good sold. For the better result and analysis, use  Net sales rather than gross sales.

Gross- Margin = Net Sales – Cost of goods sold

Generally, it is expressed in percentage which is called gross margin percentage.

Gross- Margin Percentage = (Net Sales – Cost of good sold) / Net Sales

Importance

It is helpful to analyze the sales growth rate and sales trend through the trend line graph. The significant change may require further investigation. Decline gross margin percentage is critical issue and may require management consideration.

It includes fixed and variable cost of product or services. Overhead cost is the main reason to reduce it. Overhead fluctuation and inclusion in the contribution margin effect the gross margin percentage.