What’s gross margin and why does it matter?

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What’s gross margin and Why does it matter?

Measuring and tracking gross margin throughout the business will help you set prices at the right level to make a sensible return: if you know the typical gross margins achieved by your competitors, then tracking gross margin is a really good way to keep a check on the overall health of the business when compared to rival businesses.

How do I decide what my costs are?

Gross Margin

Which Costs should be used to calculate gross margin differs greatly depending on your business type and the complexity of the processes that create the goods to be sold.

So in a manufacturing business, production staff salaries would usually be treated as Costs but in a distribution business, probably most staff salaries would be overheads.

What is gross margin?

Gross margin is usually expressed as a percentage and is calculated as the total revenue less the cost of goods sold (“Costs”) divided by the total revenue.

In this case, “Costs” means the direct costs that are incurred by making the sale. So costs of manufacture and purchase of raw materials are obviously included but rent and administrative expenses are overheads and not direct costs and so are not counted for purposes of arriving at Gross Margin.

How is Gross Margin calculated?

To calculate gross margin subtract Cost of Goods Sold (COGS) from total revenue and divide that number by total revenue:

Gross Margin = (Total Revenue – Cost of Goods Sold)/Total Revenue)

The formula to calculate gross margin as a percentage is:

Gross Margin = (Total Revenue – Cost of Goods Sold)/Total Revenue x 100.

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