- Gross margin is the simplest margin calculation. Its formula is sales minus the cost of goods sold, or variable costs. You can calculate gross margin on a single product, or for all sales in a given period. Gross margin on a single product is the difference between the sales price and variable costs. If a product sells for $10 and the costs to make that single product and sell it are $7, its gross margin is $3. Gross margin, often known as gross profit for a period, is total sales minus variable costs for one product, times the number of products sold.
- Along with analyzing the cost and sales price variables in the gross margin equation, companies also calculate a gross margin ratio to determine how their margins compare to sales. The ratio formula is gross margin, or profit, divided by sales. For instance, if you sell $50,000 of product that has a cost basis of $20,000, your gross margin is $30,000. The margin ratio is $30,000 divided by $50,000. This equals 0.6, or 60 percent. This is generally a strong ratio.
- Companies always prefer the highest margins possible on the sale of products. However, low cost providers typically maintain lower margins and try to make up with higher volume. In general, though, low margins typically indicate the company is either struggling to control variable costs, or is not able to generate enough revenue to cover fixed costs and ultimately earn a profit.
- A high margin generally means a company is in a stable and strong financial position. While margins can rise or fall in short order, a high margin typically means the company is controlling costs and has a strong brand that is leading to high sales prices and margins. Maintaining a high margin typically requires consistent quality performance and adaptation to evolving marketplace demands. Companies also need to continue to market their brand to maintain top of mind awareness and brand loyalty.
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