The gross margin ratio shows the percentage of net sales a company retains after it pays all direct costs associated with producing goods (also known as cost of goods sold).
The gross margin is equal to the difference between net sales and cost of goods sold divided by net sales, expressed as a percentage.
Gross margin can be used to measure a company's efficiency or to compare two companies of different market capitalizations.
Understanding Gross Margin
Gross margin, or gross margin ratio, is equal to the difference between net sales and cost of goods sold (or cost of sales) divided by net sales, expressed as a percentage.
The gross margin ratio shows the percentage of net sales (also known as revenue) a company retains after it deducts cost of goods sold.
The higher the gross margin, the more capital a company retains.
Gross margin can measure a company's efficiency. Companies use the gross margin to measure how their production costs relate to their revenues. If a company's gross margin is falling, it may consider slashing labor costs, increasing product prices or sourcing materials from suppliers that ask for a cheaper price.
Gross Margin vs. Net Margin
Both the gross margin and the net margin measure a company's profitability compared to its revenue for a period.
While gross margin focuses solely on the relationship between revenue and cost of goods sold, the net margin takes all of a business's expenses into account.
Net margin removes the values of interest, taxes, and operating expenses from the net sales, so it's a more conservative figure.
To conclude, gross margin helps a company assess its profitability relating to its manufacturing activities, while net margin helps the company assess its overall profitability.
Example of Gross Margin
The chart below shows the income statement from Apple's annual report for the fiscal year ending September 25, 2021.
The annual report shows that:
Apple's net sales for the fiscal year 2021 was 365.817 billion.
Apple's cost of sales for the fiscal year 2021 was 212.981 billion.