Description
| - Gross margin is the difference between revenue and cost before accounting for certain other costs. It is calculated as the selling price of an item, less the cost of goods sold (production or acquisition costs, essentially).
This is the relationship between Goss Profit and sales and it is expressed in percentage:
Gross Profit (Revenue – CoGS) x 100%
Sales
Imagine, company XYZ had $100K in Gross profit and $250K in Sales, for Year-Two, therefore:
(100/250) * 100% = 40%
It means that 60% of your income is used to cover the cost of goods sold. This ratio is very important, since, for many organizations, in particular, manufacturing, most of the costs are associated to CoGS (Cost of Goods Sold). For example, if you have to produce an Ice cream, you have to buy raw materials to make it. Also, someone has to “assemble” the Ice cream before it can be sold. Well, the raw materials and the work needed to produce the final product are considered CoGS. In other words, those are the costs required before the Ice cream can be sold. Therefore, this measure can be very helpful to assess the operational profitability of the business. In short, the Gross Profit Margin tells us whether we are adequately managing our inventories as well. (en)
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