What is Gross Margin Formula?

The gross margin derives by deducing the cost of goods sold (COGS) from the net revenue or net sales (gross sales reduced by discounts, returns, and price adjustments). When the result is divided by revenue, we can determine the gross profit percentage. The formula of gross margin in numbers and percentage terms is as follows: –

Gross Margin Formula (In Absolute Term) = Net Sales – COGS

Gross Margin Formula (In Percentage Form) = (Net Sales – COGS) * 100 / Net Sales

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Explanation

  • Gross Sales: Revenue or sales is the amount fetched by the company after selling its services or goods. Generally, all the major companies follow the accrual method of accountingAccrual Method Of AccountingAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. read more as prescribed by GAAP (Generally Accepted Accounting PrincipleGenerally Accepted Accounting PrincipleGAAP (Generally Accepted Accounting Principles) are standardized guidelines for accounting and financial reporting.read more).In the accrual system, one may record revenue or expenses as and when they occur, irrespective of whether they receive cash. The total receipt from selling the goods or services is gross revenue.Net Sales: For arriving at the net sales figure, a few items of price adjustments, deductions, and returns need to be separated from the gross revenue. The formula for net sales is as follows: –

Net Sales = Gross Sales – (Refunds + Price Adjustments + Price Deductions)

  • Cost of Goods Sold: The direct costsDirect CostsDirect cost refers to the cost of operating core business activity—production costs, raw material cost, and wages paid to factory staff. Such costs can be determined by identifying the expenditure on cost objects.read more such as raw material and labor for the units of goods sold, are considered COGS (Cost of Goods Sold). Here, we do not include indirect costsIndirect CostsIndirect cost is the cost that cannot be directly attributed to the production. These are the necessary expenditures and can be fixed or variable in nature like the office expenses, administration, sales promotion expense, etc.read more such as selling and administration expenses.The remaining goods are known as inventory, whether in a finished or unfinished condition. So, we take opening inventory So, we take opening inventory (closing inventoryClosing InventoryClosing stock or inventory is the amount that a company still has on its hand at the end of a financial period. It may include products getting processed or are produced but not sold. Raw materials, work in progress, and final goods are all included on a broad level.read more of the previous year), add purchases and other direct expenses, and deduct the closing inventory (stock of unsold products). It is calculated as follows: –

COGS = Opening Inventory + Purchases – Closing Inventory

Steps to Calculate Gross Margin

One can do the calculation of the gross margin equation by using the following steps: –

  • Firstly, we would calculate the net sales by deducting returns, discounts, and other adjustments in the sales amount.Then, the Cost Of Goods SoldCost Of Goods SoldThe Cost of Goods Sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company.
  • read more (COGS) would derive by adding all the purchases, direct cost (labor and material), opening inventory, and subtracting the closing inventory.Now, we could calculate the gross margin by reducing COGS from net sales.To arrive at the gross margin percentage, we need to divide the gross margin (calculated above) by the net sales.

Examples of Gross Margin Formula(with Excel Template)

Let us see some simple to advanced models of the gross margin equation to understand it better.

Gross Margin Formula Example #1

As of September 28, 2019, Apple Inc. has sold products and services worth $213,833 million and $46,291 million. The cost of goods sold includes the price allocated to products and services amounting to $144,996 million and $16,786 million each. Now, let us find out the gross margin and gross margin percentage.

Solution:

Use the below-given data for the calculation of gross margin: –

Calculation of gross margin can be done as follows: –

Gross margin = $260174 – $161782

The gross margin will be: –

Gross Margin = $98,392

Calculation of gross margin % can be done as follows: –

Gross margin (%) = ($260174 – $161782) * 100% / $260174

The gross margin (%) will be: –

Gross Margin (%) = 38%

Explanation 

The gross margin equation expresses the percentage of gross profitPercentage Of Gross ProfitGross profit percentage is used by the management, investors, and financial analysts to know the economic health and profitability of the company after accounting for the cost of sales. Gross profit percentage formula = Gross profit / Total sales * 100% read more; the company earns from $1 of sales. In the above case, Apple Inc. has reached a gross margin of $98,392 and 38% in percentage form. This 38% gross margin indicates that out of $1 of revenue from net sales, Apple Inc. can make a gross profit of 0.38 cents.

Gross Margin Formula Example #2

For the year ended June 30, Microsoft Inc. had revenue from products and services and another department of $66,069 million and $59,774 million, respectively. Also, in the same period, the cost of revenue Cost Of RevenueThe cost of revenue is the total expense incurred from manufacturing to delivering a product or service to the customer. It reflects all direct costs associated with the product or service delivered and is reflected in a company’s income statements.read more for products and services and another dept. is $16273 million and $26,637 million, respectively. Therefore, we will try calculating the gross profit marginGross Profit MarginGross Profit Margin is the ratio that calculates the profitability of the company after deducting the direct cost of goods sold from the revenue and is expressed as a percentage of sales. It doesn’t include any other expenses into account except the cost of goods sold.read more from the data above.

Calculation of gross margin in Excel can be done as follows: –

Gross Margin = $125843 – $42910

Gross Margin will be –

Gross Margin = $82,933.

Calculation of gross margin (%) can be done as follows:

Gross Margin (%) = ($125843 – $42910) * 100 % / $125843

Gross Margin (%) will be: –

Gross Margin (%) = 66%

Explanation

As we can see, Microsoft Inc. has clocked the gross margin to $82,933 million and 66% in percentage. As Microsoft Inc. and Apple Inc. are in similar fields, we would be able to compare these companies. Apple Inc. has a gross margin of $98,392 million. At the same time, Microsoft Inc. has earned only $82,933 million in the absolute term. But, regarding the percentage figures, Microsoft Inc. has a superior margin at 66% compared to 38% of Apple Inc.

Relevance and Uses of Gross Margin Formula

The gross margin is important in evaluating the company for various purposes. A few noted ones are below: –

This article is a guide to Gross Margin Formula. Here, we discuss the calculation of gross margin and its percentage (%) using its formula and examples with a downloadable Excel template. You can learn more about financial analysis from the following articles: –

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