3.3. Gross Profit and Gross Margin
Lesson objective
Measure the basic economics of the product or service.
Gross Profit is Revenue minus Cost of Revenue. Gross Margin divides Gross Profit by Revenue and shows what remains to cover operating expenses, interest, taxes, and profit.
The contents of Cost of Revenue differ by industry. In software, it may include infrastructure and support. In manufacturing, it may include materials and production.
Changes in product mix, pricing, and direct costs can alter the margin even when sales rise.
Gross profit shows what remains after direct costs
Gross profit = Revenue − Cost of revenue
Gross margin = Gross profit ÷ Revenue × 100
Worked example
Revenue = $500M and cost of revenue = $300M. Gross profit = $200M and gross margin = 40%. If revenue later rises to $550M while cost rises to $352M, gross margin falls to 36%: sales grew, but less gross profit remained per revenue dollar.
What can move gross margin?
Pricing, product mix, input costs, freight, cloud/infrastructure costs, discounts, and capacity utilization. The percentage is a clue; the filing should explain the economics behind it.
In Finzati
Company Snapshot makes it easier to compare Gross Margin among companies.
What you should remember
- Understand what the company includes in direct costs.
- Compare with economically similar competitors.
Practice
Identify a year of margin improvement or deterioration and search for an explanation in the company's report.