The gross margin is the profit without considering taxes and general expenses, unlike what happens with the net profit.
The gross margin is the direct profit achieved from the marketing of a service or product. It can be calculated as the difference between the price that was set for sale (subtracting the Value Added Tax) and the cost involved in its production.
It should be noted that, in the field of economics and finance, the idea of margin refers to profit, utility or performance. The adjective gross , in this framework, indicates that no discount or withholding was applied to said amount or amount.
It is noted that the gross margin is a direct profit because taxes (such as the aforementioned VAT) or general expenses are not considered . If the gross margin is negative, it implies that the sales price does not cover production costs, which means there is no profitability. Typically, the gross margin is expressed as a percentage through the result of the following equation:
Gross margin = (Sales revenue – Production costs) / Sales revenue
Gross margin, an analysis tool
Gross margin is considered a very valuable analysis tool as it provides key information about a company's profitability. As we already indicated, if the indicator is negative, it is impossible for the company to be profitable since the cost of goods sold (COGS) is higher than sales .
Even if the gross margin is positive, profitability is not assured. It is essential that the entity achieves a gross margin sufficient to cover its operating expenses and fixed costs and also obtain profits .
It may be the case that the company has a gross margin that allows it to cover all of its costs, but without registering profits. This situation is mentioned as the break-even point or profitability threshold and is equivalent to total revenues and total costs being equal.
Cost control is vital to maximizing gross margin.
Different approaches
When the gross margin is expressed as a percentage, calculated from the income generated by all sales, it is considered to make it possible to know operational efficiency .
Suppose a shoe manufacturer records revenue of $100 from the sale of shoes that cost $40 to produce . This represents that the gross margin on each pair of shoes is $60, or 60% if expressed as a percentage. Therefore, for every dollar you receive in sales, you achieve $0.60 in return .
The net margin , on the other hand, is the result that arises when fixed expenses are subtracted from the gross margin. It can be said that this value is the final profit.
The evolution of the gross margin is frequently examined. By comparing different periods, you can discover if gross profit is growing but gross margin is falling, to mention one possibility. This usually happens when it is necessary to increase fixed expenses to increase sales, a situation that can even lead to losses .
The gross margin can provide information about the solvency of a company.
The gross margin in the income statement
Gross margin is one of the components of the income statement . This accounting document, also known as a profit and loss account , presents the expenses and income that a company had in a certain time period. The income statement, therefore, is a financial statement .
This income statement is developed in a series of steps. First the gross margin is calculated and then the administration, personnel and general expenses are successively considered (to calculate EBITDA ); amortization expenses and provisions (to know the EBIT ); extraordinary income and extraordinary expenses (to arrive at EBT ); and corporate tax (to know the result of the year ). It is possible to incorporate other stages, a decision that depends on the company's directors and the characteristics of the business.
Some drawbacks
Although we have already alluded to the usefulness of calculating the gross margin, in some contexts the indicator is not entirely appropriate for drawing conclusions . This has been noted, for example, in the agricultural-livestock industry.
The lack of consideration of the incidence of financial costs derived from the immobilization for the conservation of stocks; the lack of distinction between structural costs and variable costs; and the usual confusion between variable costs, fixed costs, indirect costs and direct costs are some of the problems that may appear when a rural producer calculates the gross margin of his activity.
Gross margin optimization
For a company to be profitable, a good gross margin is needed. Maximizing this indicator is very important in any undertaking.
Among the experts' recommendations to increase the gross margin are the diversification of the product offering to increase total sales; the incorporation of technology and the automation of processes to achieve an improvement in the efficiency of the production process; and negotiating to get lower prices from suppliers.