Gross Margin

Gross profit as a percentage of revenue.

Gross margin is a profitability metric that measures the percentage of revenue a company retains after paying for the direct costs of producing its goods or services. These direct costs, known as Cost of Goods Sold (COGS), include raw materials, direct labor, and manufacturing overhead. By showing how efficiently a company manages its production costs relative to its sales, gross margin serves as a fundamental indicator of core pricing power and manufacturing efficiency. To calculate gross margin, you subtract COGS from total revenue to find the gross profit, and then divide that figure by total revenue. The result is expressed as a percentage. Because it focuses strictly on production costs, gross margin excludes indirect expenses such as marketing, administration, research and development, interest, and taxes. This makes it highly useful for comparing the operational efficiency of companies within the same industry. Investors closely monitor gross margin because a high or expanding margin suggests a company can price its products premiumly or produce them cheaply, providing a buffer to cover operating expenses and reinvest in growth. Conversely, a low or declining gross margin may signal rising raw material costs, pricing pressure from competitors, or inefficient production processes. When analyzing gross margin, it is critical to compare companies within the same sector, as capital-intensive industries like manufacturing naturally have much lower gross margins than asset-light sectors like software.

Company A generates $1,000,000 in revenue and incurs $400,000 in Cost of Goods Sold (COGS) to manufacture its products. Its gross profit is $1,000,000 - $400,000 = $600,000. To find the gross margin, divide the gross profit by the revenue: $600,000 / $1,000,000 = 0.60, or 60%.