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Gross margin

Gross margin is the difference between revenue and cost of goods sold (COGS) divided by revenue. Gross margin is expressed as a
percentage. Generally, it is calculated as the selling price of an item, less the cost of goods sold (e.g. production or acquisition costs,
not including indirect fixed costs like office expenses, rent, or administrative costs). Gross Margin is often used interchangeably with
Gross Profit, but the terms are different. When speaking about a monetary amount, it is technically correct to use the term Gross
Profit; when referring to a percentage or ratio, it is correct to use Gross Margin. In other words, Gross Margin is a percentage value,
while Gross Profit is a monetary value.

Gross Margin is a type of profit margin, specifically a form of profit divided by net revenue: for example, gross (profit) margin;
operating (profit) margin; net (profit) margin; etc.

Contents
Purpose
Percentage margins and unit margins
What is a unit?
References

Purpose
[1]
The purpose of margins is "to determine the valueof incremental sales, and to guide pricing and promotion decision."

"Margin on sales represents a key factor behind many of the most fundamental business considerations, including budgets and
forecasts. All managers should, and generally do, know their approximate business margins. Managers differ widely, however, in the
[1]
assumptions they use in calculating margins and in the ways they analyze and communicate these important figures."

Percentage margins and unit margins


Gross margin can be expressed as a percentage or in total financial terms. If the latter, it can be reported on a per-unit basis or on a
per-period basis for a company.

"Margin (on sales) is the difference between selling price and cost. This difference is typically expressed either as a percentage of
selling price or on a per-unit basis. Managers need to know margins for almost all marketing decisions. Margins represent a key
factor in pricing, return on marketing spending, earnings forecasts, and analyses of customer profitability." In a survey of nearly 200
senior marketing managers, 78 percent responded that they found the "margin %" metric very useful while 65 percent found "unit
margin" very useful. "A fundamental variation in the way people talk about margins lies in the difference between percentage
margins and unit margins on sales. The difference is easy to reconcile, and managers should be able to switch back and forth between
the two."[1]

What is a unit?
"Every business has its own notion of a 'unit,' ranging from a ton of margarine, to 64 ounces of cola, to a bucket of plaster. Many
industries work with multiple units and calculate margin accordingly. . . . Marketers must be prepared to shift between varying
perspectives with little effort because decisions can be rounded in any of these perspectives."[1]
Investopedia defines Gross margin as:

Gross Margin (%) = (Revenue – Cost of goods sold) / Revenue[2]

It can be expressed in absolute terms:

Gross margin = net sales – cost of goods sold + annual sales return

or as the ratio of gross profit to revenue, usually in the form of a percentage:

Cost of sales (also known as cost of goods sold or COGS) includes variable costs and fixed costs directly linked to the sale, such as
material costs, labor, supplier profit, shipping-in costs (cost of getting the product to the point of sale, as opposed to shipping-out
costs which are not included in COGS), etc. It does not include indirect fixed costs like office expenses, rent, administrative costs,
etc.

Higher gross margins for a manufacturer reflect greater efficiency in turning raw materials into income. For a retailer it will be their
markup over wholesale. Larger gross margins are generally considered ideal for most companies, with the exception of discount
retailers who instead rely on operational efficiency and strategic financing to remain competitive with lower mar
gins.

Two related metrics are unit margin and margin percent:

Unit margin ($) = Selling price per unit ($) – Cost per unit ($)
Margin (%) = Unit margin ($) / Selling price per unit ($) * 100

"Percentage margins can also be calculated using total sales revenue and total costs. When working with either percentage or unit
[1]
margins, marketers can perform a simple check by verifying that the individual parts sum to the total."

To verify a unit margin ($): Selling price per unit = Unit margin + Cost per Unit
To verify a margin (%): Cost as % of sales = 100% – Margin %

"When considering multiple products with different revenues and costs, we can calculate overall margin (%) on either of two bases:
-weighted average of the percentage margins of the different products."[1]
Total revenue and total costs for all products, or the dollar

How gross margin is used in sales

Retailers can measure their profit by using two basic methods, markup and margin, both of which give a description of the gross
profit. The markup expresses profit as a percentage of the retailer's cost for the product. The margin expresses profit as a percentage
of the retailer's sales price for the product. These two methods give different percentages as results, but both percentages are valid
descriptions of the retailer's profit. It is important to specify which method you are using when you refer to a retailer's profit as a
percentage.

Some retailers use margins because you can easily calculate profits from a sales total. If your margin is 30%, then 30% of your sales
total is profit. If your markup is 30%, the percentage of your daily sales that are profit will not be the same percentage.

Some retailers use markups because it is easier to calculate a sales price from a cost using markups. If your markup is 40%, then your
sales price will be 40% above the item cost. If your margin is 40%, your sales price will not be equal to 40% over cost (in fact, it will
be approximately 67% above the item cost).

Markup
The equation for calculating the monetary value of gross mar
gin is: gross margin = sales – cost of goods sold

A simple way to keep markup and gross margin factors straight is to remember that:

1. Percent of markup is 100 times the price difference divided by the cost.
2. Percent of gross margin is 100 times the price dif
ference divided by theselling price.

Gross margin (as a percentage of Revenue)

Most people find it easier to work with gross margin because it directly tells you how much of the sales revenue, or price, is profit. In
reference to the two examples above:

The $200 price that includes a 100% markup represents a 50% gross margin. Gross margin is just the percentage of the selling price
that is profit. In this case 50% of the price is profit, or $100.

In the more complex example of selling price $339, a markup of 66% represents approximately a 40% gross margin. This means that
40% of the $339 is profit. Again, gross margin is just the direct percentage of profit in the sale price.

In accounting, the gross margin refers to sales minus cost of goods sold. It is not necessarily profit as other expenses such as sales,
administrative, and financial must be deducted. And it means companies are reducing their cost of production or passing their cost to
customers. The higher the ratio, the better.

Converting between gross margin and markup(Gross Profit)

Converting markup to gross margin

Examples:

Markup = 100% = 1

Markup = 66.7% = 0.667

Converting gross margin to markup

Examples:

Gross margin = 50% = 0.5

Gross margin = 40% = 0.4


Using gross margin to calculate selling price

Given the cost of an item, one can compute the selling price required to achieve a specific gross margin. For example, if your product
costs $100 and the required gross margin is 40%, then

Selling price = $100 / (1 – 40%) = $100 / 0.6 = $166.67

Gross Margin tools to measure retail performance Some of the tools that are useful in retail analysis are GMROII, GMROS and
GMROL.

GMROII: Gross Margin Return On Inventory Investment

GMROS: Gross Margin Return On Space

GMROL: Gross Margin Return On Labor

Differences between industries

In some industries, like clothing for example, profit margins are expected to be near the 40% mark, as the goods need to be bought
from suppliers at a certain rate before they are resold. In other industries such as software product development the gross profit
margin can be higher than 80% in many cases.[3]

References
As of February 5, 2012, this article is derived in whole or in part from Marketing Metrics: The Definitive Guide to Measuring
Marketing Performance by Farris, Bendle, Pfeifer and Reibstein. The copyright holder has licensed the content in a manner that
permits reuse under CC BY-SA 3.0 and GFDL. All relevant terms must be followed.

1. Farris, Paul W.; Neil T. Bendle; Phillip E. Pfeifer; David J. Reibstein (2010).Marketing Metrics: The Definitive Guide
to Measuring Marketing Performance.Upper Saddle River, New Jersey: Pearson Education, Inc. ISBN 0-13-705829-
2. The Marketing Accountability Standards Board (MASB)endorses the definitions, purposes, and constructs of
classes of measures that appear inMarketing Metrics as part of its ongoing Common Language in Marketing Project
(http://www.commonlanguage.wikispaces.net/).
2. Definition of 'Gross Margin'(http://www.investopedia.com/terms/g/grossmargin.asp). investopedia.com
3. http://smallbusiness.chron.com/net-profit-percentage-goals-business-23447.html
- "Software companies had a 90
percent gross profit margin, as of 2011, according to FinanceScholar
."

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