Dictionary of all accounting terms
Gross margin is the percentage of revenue a company hangs on to after the expenses related to the total production have been subtracted.
The larger the percentage, the bigger portion of revenue is retained by the company after all production costs are accounted for.
In order to calculate gross margin, you must subtract the cost of good sold from your total revenue then divide the number from your total revenue.
My company has sold $1,000,000 worth of goods this fiscal year. The total cost associated with production of goods sold was $600,000. In the cost of production, we need to include the labor costs, cost of raw materials, transportation costs, and any other costs that are directly associated with production.
1,000,000 - 600,000 = 400,000
400,000 / 1000,000 = 0.40
0.4 x 100 = 40% Gross Margin
Calculating the gross margin is incredibly important for any business. It gives them the insight as to how production costs relate to revenue and in turn, profitability of the venture. Understanding the gross margin of your business will also allow you to gauge your ability to cover other essential operating expenses.