Profitability
Gross Margin
Gross margin is the share of revenue left after the direct cost of producing what was sold.
Gross margin is the first look at pricing power and production cost. A software firm with an 80% gross margin and a grocer with a 25% gross margin are not equally 'profitable' at the gross line, and they should not be asked to be. What matters is the direction inside one company and the gap versus peers who make the same thing.
A falling gross margin means the company is paying more to serve each sale or charging less. That shows up later in operating margin and in earnings. Catch it at the gross line and you are early. A rising gross margin with flat revenue can be a mix shift toward better products, which is often the healthier kind of improvement.
Formula
Gross margin = (revenue − cost of goods sold) ÷ revenue
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Questions
What is a good gross margin?
Relative to direct competitors. 40% is excellent for a manufacturer and ordinary for a software firm.
Does gross margin include marketing?
No. Marketing, research, and head-office costs sit below the gross line, in operating expenses.