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Formula
Gross Margin = (Total Revenue − Cost of Goods Sold)/Total Revenue × 100
Know your metric
Importance of
Gross Margin
Gross margin, calculated as the difference between revenue and cost of goods sold (COGS) divided by revenue, is a key profitability indicator for a company. It measures how much a company earns from each sale after accounting for the costs directly associated with producing its goods or services.
Key importance of this lies in measuring
Profitability
Gross margin is key for tech companies, indicating product or service profitability and resource use efficiency.
Cost Control
It allows assessment and optimization of costs, informing decisions on pricing and production to enhance cost efficiency.
Financial Health
A vital sign of a tech company's financial status, gross margin shows revenue generation capability and sustainability, with high margins suggesting health and low margins signalling financial concerns that require attention.
Drawbacks of
Gross Margin
Gross margin is a useful profitability metric, but it has limitations that require careful consideration
Excludes Operating Expense
It doesn't include marketing, administrative, or R&D costs, which can obscure a company's true profitability.
Industry Variance
It's not ideal for cross-industry comparisons, as different industries have varying cost structures.
Ignores Pricing/Cost Changes
It fails to account for shifts in pricing strategies or COGS, affecting long-term profitability assessments.
To address these issues, businesses should supplement gross margin with other financial metrics and conduct in-depth analyses for a complete profitability picture.
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