Gross Margin Formula (Table of Contents)
What is the Gross Margin Formula?
The term “Gross Margin” refers to the profitability measure that assesses whether or not a company is able to run its operation efficiently and generate enough profit. Basically, gross margin determines the profitability after adjusting the costs of production that can be directly assigned to the manufacturing process. Such directly assignable costs primarily include raw material cost, direct labor expense and manufacturing overhead and are they collectively known as the cost of goods sold or cost of sales. Some of the companies report a gross profit as a line item in the income statement.
The formula for gross margin is very simple and can be derived by dividing the difference between the net sales and the cost of goods sold by the net sales, which is then expressed in terms of percentage by multiplying with 100%.
Mathematically, it is represented as:
The formula for Gross Margin Formula:
Example of Gross Margin Formula (With Excel Template)
Let’s take an example to see the calculation of Gross Margin in a better manner.
Example #1
Let us take the example of ASD GmbH CO KG to illustrate the computation of gross margin. The company is based out of Germany and it manufactures corrugated boxes that are supplied to parts of the country. According to its annual report for the year 2018, the company successfully clocked net sales of €27.8 million during the year. Calculate the gross margin of the company if the following cost break-up is available.
Solution:
Cost of Goods Sold is calculated using the formula given below
Cost of Goods Sold = Raw Materials Cost + Direct Labor Cost + Factory Rental Expense
- Cost of Goods Sold = €9.50 million + €6.50 million + €1.20 million
- Cost of Goods Sold = €17.20 million
Gross Margin is calculated using the formula given below
Gross Margin = (Net Sales – Cost of Goods Sold) / Net Sales * 100
- Gross Margin = (€27.80 million – €17.20 million) / €27.80 million * 100%
- Gross Margin = 38.13%
Therefore, the Gross Margin of the Company was 38.13% for the year 2018.
Example #2
Let us take the example of Samsung to illustrate the computation of gross margin for a real-life company. The recent annual report states that the company achieved revenue of $221.57 billion in 2018 vis-à-vis $217.75 billion in 2017. On the other hand, the corresponding cost of sales was $120.34 billion in 2018 vis-à-vis $117.51 billion in 2017. Calculate the gross margin of the company for the year 2017 and 2018.
Solution:
Gross Margin is calculated using the formula given below:
Gross Margin = (Revenue – Cost of Goods Sold) / Revenue * 100
For Year 2017
- Gross Margin = ($217.75 billion – $117.51 billion) / $217.75 billion * 100
- Gross Margin = 46.03%
For Year 2018
- Gross Margin = ($221.57 billion – $120.34 billion) / $221.57 billion * 100
- Gross Margin = 45.69%
Therefore, Samsung’s Gross Margin deteriorated slightly to decline from 46.03% in 2017 to 45.69% in 2018.
Example #3
Let us take the example of Walmart Inc. for the computation of gross margin. According to the annual report for the year 2018, the company achieved net sales of $495.76 billion and incurred the corresponding cost of sales of $373.40 billion. Calculate the gross margin of the company for the year 2018.
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Solution:
Gross Margin is calculated using the formula given below:
Gross Margin = (Revenue – Cost of Goods Sold) / Revenue * 100
- Gross Margin = ($495.76 billion – $373.40 billion) / $495.76 billion * 100%
- Gross Margin = 24.68%
Therefore, Walmart Inc.’s Gross Margin for the year 2018 was 24.68%.
Explanation:
The formula for Gross Margin can be calculated by using the following steps:
Step 1: Firstly, figure out the net sales which are usually the first line item in the income statement of a company.
Step 2: Next, figure out the cost of goods sold or cost of sales from the income statement. It is either available as a line item or has to be computed by adding up all the costs of production that can be directly assigned to production.
Step 3: Next, calculate the gross profit by deducting the cost of goods sold (step 2) from the net sales (step 1).
Gross Profit = Net Sales – Cost of Goods Sold
Step 4: Finally, the formula for gross margin can be derived by dividing the gross profit (step 3) by the net sales (step 1) and then multiply by 100% as shown below.
Gross Margin = (Net Sales – Cost of Goods Sold) / Net Sales * 100
Relevance and Use
It is important to understand the concept of gross margin because it helps the management of a company to better assess its own operational efficiency and profitability in a general sense. But it is very difficult to judge what can be considered a healthy gross margin. Inherently, analysts benchmark the gross margin based on the margins of the industry peers and any company performing better than that benchmark is considered to be good.
Gross Margin Formula Calculator
You can use the following Gross Margin Formula Calculator
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