Gross margin refers to a company’s percentage that is equal to the total revenue that the company has taken in, minus the cost of goods sold and then you divide that number by the total revenue number. This formula will give you a business’s gross margin.
The gross margin number represents the portion of each dollar of revenue that the company is able to retain as gross profit. Let’s take, for example, a company whose most recent quarter had a gross margin of 35%. This company would be able to retain $0.35 from each dollar of revenue that is generated through the business. This money can be applied to general and administrative expenses, interest expenses and paying distributions to shareholders.
Gross margins can vary greatly depending on the industry you happen to be in. For example, the high tech and software industries generally have a much higher gross margin than a company that was involved in manufacturing. However, if a manufacturer is able to turn out a higher gross margin, then this might reflect this company’s ability to have a greater efficiency in turning their raw materials into profit. And, for example, if a retailer had a higher gross margin than previous periods this may reflect the company’s markup on the goods over the wholesale cost.
Let’s take a closer look. If a retailer took an item and marked it up to $200 and that amount reflected a 100% markup then the markup would represent a 50% gross margin. Larger gross margins are usually a good sign for companies.