An Overview of Gross Margin
The gross margin shows the amount that a business has earned from selling its products or services before deducting any selling and administrative expenses (Also see Direct Expenses and Indirect Expenses). The sum of gross margin shows how much funds the company is left with to pay for activities it carries out to earn a profit, the financing costs, as well as the selling and administrative activities. It plays a significant role when the business owners want to derive a budget as it influences the sum of expenses (Also see Accounting for Expenses) that their companies can spend on those extra expense categories. Hence, business owners like you should pay attention to the gross margin of the company to have a better understanding of its financial position. However, calculating gross margin requires some skills and knowledge in accounting as well as well-organised bookkeeping records so that business owners can get accurate figures about the sales and expenses of the company. If bookkeeping is not your thing, you should consider hiring an in-house bookkeeper or outsourcing your bookkeeping-related tasks to a bookkeeping firm in Singapore.
The figures for gross margin can be very different in various industries. As an instance, if your company sells electronic downloads on a website, your gross margin can be extremely high as you do not sell any physical products that you may need to assign costs on them. In contrary, if you run a business that sells physical products like cars, then your gross margin may be much lower.
When calculating gross margin, you should use net sales (Also see Can You Differentiate Net Income and Net Sales?) compared to gross sales. This is because you need to deduct a lot of amounts from the gross sales, and the deductions may affect the outcome of the calculation. People would typically express gross margin in percentage. To calculate it, you should subtract the cost of goods sold from your nets sales and divide the resulting amount by your net sales. You need to state the gross margin in the income statement (Also see Accounting – 4 Tips for Analyzing an Income Statement) of your company.
Gross margin can be very helpful if you track it on a trend line as it helps you to detect any notable changes that you may need to look into them. You should be careful when the gross margin of your company has decreased since this may be a sign that the competitiveness of the products or services of your company in the market has declined.
When you analyse your company’s gross margin, you should also consider the rate of inventory turnover. From the perspective of the sum of annual return on investment (Also see Accounting – Guide to Calculating Return on Capital Employed), if the rate of inventory turnover is high and the gross margin is low, it carries the same meaning as having a low inventory turnover rate and a high gross margin.