ruly Gross margin: what is left after the cost of sales
Definition of gross margin, its formula, where to find it in an annual report, usual levels by sector, the traps of reading it and the limits of the indicator for investors.
Published
Definition
Gross margin is the share of revenue left once the direct cost of what the company billed its customers has been paid: raw materials, production, merchandise. It measures the company’s ability to charge clearly more for its products than they cost, before sales, administrative and research expenses.
Formula
Gross margin = (revenue − cost of sales) / revenue
Where to find it in an annual report
Income statement. Cost of sales sometimes goes by another name, such as cost of revenue. Some companies present their expenses by nature rather than by function: gross margin then does not appear directly and has to be rebuilt, which makes it less comparable.
Common thresholds
The level depends mainly on the business model. A software company often exceeds 70%, a consumer goods brand is often between 40 and 60%, a retailer or a manufacturer can stay below 30% and still be profitable. Comparing a company with its sector and its own past makes more sense than a single threshold.
In the preset strategies
| Preset strategy | Criterion met | To monitor | Criterion not met |
|---|---|---|---|
| Long-term quality Gross margin | ≥ 40% | 25% to 40% | < 25% |
| Reasonable growth Gross margin | ≥ 50% | 35% to 50% | < 35% |
Pitfalls
- A high gross margin says nothing about other expenses: a company can show a 70% gross margin and lose money.
- What goes into cost of sales varies from one company to another (depreciation, logistics): compare companies that present it the same way.
- A one-off increase can come from exchange rates or raw material prices: look at the trend over several years.
Where it does not apply
- Banks and insurers: their income statement has no cost of sales.
- Companies that present expenses by nature, when cost of sales cannot be rebuilt.
A worked example
A fictitious company, called Company B here, generates €200 million of revenue for a cost of sales of €110 million. Its gross margin is (200 − 110) / 200 = 45%.
Why follow it over time
A gross margin that is stable or rising over several years suggests that the company passes its costs on to its prices. A margin that erodes can signal fiercer competition or costs it cannot pass on.
Sources
- Annual reports of listed companies (income statement)