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Gross Margin Ratio

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Examples

Example 1:
Calculate the monthly gross margin for Lydecker Corporation, when:

  • Monthly revenue = $744,200
  • Cost of selling goods = $503,890
  • Gross margin ratio = (monthly revenue – cost of selling goods) ÷ monthly revenue = ($744,200 − $503,890) ÷ $744,200 = 0.32

Example 2:
Calculate the gross margin ratio for Hickman Cycles, when:

  • Cost of goods sold = $8,754,000
  • Gross profit for the month = $2,423,000
  • Calculate total revenues = gross profit + cost of goods sold = $8,754,000 + $2,423,000 = $11,177,000
  • Calculate the gross margin = gross profit ÷ revenue = $2,423,000 ÷ $11,177,000 = 0.22

Overview

The gross margin ratio measures a company’s profitability. Specifically, it describes how much of a company’s revenue is gross profit. So, the ratio is a measure of efficiency—the amount of profit gained for each dollar of revenue.

Gross margin is the difference between revenue (value of goods and services sold) and costs before accounting for certain other costs. Generally, it is calculated as the selling price of an item, less the cost of goods sold (production or acquisition costs).

When gross profit is calculated by subtracting the cost of goods sold from revenue, the formula may be restated as:

Gross Margin = (Revenue − Cost of Goods Sold) / Revenue

Lenders and investors generally calculate this ratio to determine the value of incremental sales (additional revenue generated through sales and special promotions) and to guide pricing and marketing decisions. Margin on sales represents a key factor behind many fundamental business considerations, including budgets and forecasts.

Analysis

Investors and lenders view higher gross margin ratio values more favorably than lower ones. Higher values indicate greater efficiency: more cents earned per dollar of revenue. More profit is available to pay for non-production costs. The gross margin ratio values mean different things to businesses in different industries. For example, for manufacturers, gross margins measure the efficiency of the production process. For small retailers, the ratio can reflect smart pricing strategy of the business. In this case, higher gross margin ratio means that the retailer charges higher markups on goods sold.

Gross Margin = Gross Profit / Revenue