Gross margin

There are many ways to measure a firm’s profitability. One of the more important ones is the gross margin. This compares gross profit (sales minus cost of goods sold) with the sales figure as a percentage.

So if a firm’s sales are £1m with cost of sales of £800,000, gross profit is £200,000 and the gross margin is 20% – ie, (200,000/1m) x 100%. The higher the figure the better, as it indicates that the firm’s core activity is profitable.

However, by itself it is not the full picture. It excludes overheads. That’s why analysts often also calculate an operating profit margin too (operating profit is gross profit less selling, distribution and administration costs). They also usually look at net margin – operating profit after deducting finance costs. So there are many ways of expressing a ‘profit’.

Merryn

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