Gross margin is a ratio that measures how profitable your company is.
It represents the percentage of total sales revenue that your company retains after incurring the direct costs associated with the production of the goods and services sold.
The higher the margin, the more your company can retain on each euro of sales to set its other costs and obligations.
It can be calculated in the following ways:
How do profit margin and gross margin differ?
They are often confused, but in the end they are two completely different metrics.
The profit margin is the money earned from a sale minus the direct costs of a sale and the gross margin is the profit expressed as a percentage of sales.
However, some companies prefer to use this calculation and express it as in euros or as a percentage.
If you have sales of €100, but cost €40 in raw materials and labour, you are left with a profit of €60, and a gross margin of 60% or €60.
On the income statement, you will have many other expenses below the gross margin, e.g. operating expenses, interest, taxes.
So this metric is not a complete picture of your profit; just look at the amount of money left over after the direct costs of the sale.
You have a home cooking business, and you send a cook to work in a house for a couple of hours.
You plan to charge €50, but you will pay your cook €20, and the kitchen items cost €4.
Your direct costs are €24 of the 50, which leaves €26 of profit. Your gross margin is 52% (or €26).
Direct costs include:
- The cost of paying the cook
- The kitchen items that were sold out.
Direct costs that are not included:
- The cost of paying each time the phone is answered.
- The cost of advertising.
- The cost of any tools that could be reused.
The gross margin of €26 (52%) is needed to pay for your equipment salary, advertising and other necessary costs.
Therefore, no company, not even a non-profit one, can afford to have 0 in this metric, or they will go out of business.
Two ways to achieve the Gross Margin
Well, we talked earlier about the higher the margin, the more your company retains on each euro in sales to fix other costs you have.
Moreover, gross margins can be achieved in two ways:
The first is to buy a low-cost inventory.
If you get a large purchase discount when you buy a product from a manufacturer or wholesaler, your gross margin will be higher because your costs will be lower.
The second way is to get the raw material at high prices.
This obviously has to be done in a competitive way, otherwise the products will be too expensive and customers will buy elsewhere.
It is clear that if your company has a high gross margin rate it will have more money to pay operating expenses such as salaries, utilities and rent.
Since this index measures profits on sales, it also measures the percentage of sales that can be used to help finance other parts of the business.
Did you know that a CRM can help you to calculate your gross margin?
Yes, because it will help you generate reports where you can analyse the effectiveness and return on investment of each of the actions you take.
In addition, you can link and share information with your commercials in a very clear way.
Try it out now!
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