What Is Gross Margin?
Gross margin measures how much revenue remains after direct costs. It is one of the first profitability checkpoints on an income statement.
How gross margin is calculated
The basic formula is:
- Gross margin = gross profit ÷ revenue
Gross profit is revenue minus cost of goods sold or cost of revenue. If a company has $100 million in revenue and $60 million in direct costs, gross profit is $40 million and gross margin is 40 percent.
Why gross margin matters
Gross margin can show whether a company has pricing power, production efficiency, or cost pressure. A rising gross margin may mean the company is selling higher-value products, raising prices, improving efficiency, or benefiting from lower input costs. A falling margin may point to discounts, inflation, mix changes, or competitive pressure.
Compare the right peers
Gross margins vary widely by industry. Software companies often have different gross margins than retailers, automakers, or energy producers. Comparing unrelated industries can mislead.
Track gross margin over several periods and read management's explanation. The reason for the margin change matters more than the number alone.