Gross margin

What it means

Gross margin is the difference between sales and the direct cost of goods or products sold, expressed in euros or as a percentage of sales. It shows how much of each euro of sales is left to cover overheads such as rent, administrative salaries or marketing, and to provide profit.

In trading, the direct cost is the purchase price of goods sold; in manufacturing it is materials, direct labour and other direct costs. If a company sells for 100 euros goods it bought for 70 euros, the gross margin is 30 euros, or 30 percent.

Gross margin must be distinguished from markup, which is calculated on the purchase price. A 25 percent markup on goods costing 80 euros gives a selling price of 100 euros but a margin of only 20 percent, and confusing the two leads to pricing errors.

How it works in practice

Tracking gross margin by product, customer or channel shows what really makes the company money. A high-volume, low-margin product may earn less than a slower-selling product with a high margin, and discounts erode margin faster than it seems.

Gross margin must cover overheads. If it is lower than fixed costs, the company makes a loss regardless of sales volume, and growing low-margin sales can even deepen the loss if servicing costs grow too.

When comparing with competitors or the sector, you need to know what is included in direct costs. Some companies include delivery or commissions and others do not, and in analysis gross margin is read together with the EBITDA margin.

What to watch out for

Rising purchase prices hit the margin immediately, while selling prices adjust with a lag. In times of inflation, margins must therefore be monitored continuously and prices adjusted in time, or the company sells more and earns less.

Accounting gross margin depends on correct inventory valuation. Errors in stock records, shortages or misallocated costs distort the margin, and the company may make pricing decisions based on wrong figures.