Gross margin

Revenue is everything customers paid. Cost of goods sold, also called cost of revenue, is what it cost to make or purchase what was delivered: materials, factory wages, the price paid to suppliers, and for many companies shipping and the running of data centres.

Gross profit is what is left. Gross margin is that profit as a share of revenue. A gross margin of 40% means 40 cents of every dollar of revenue remain to pay for everything else and, after that, to become operating profit.

Both numbers open the income statement. Many companies report gross profit as its own line; when they do not, it can be worked out from revenue and cost of revenue.

A company has $1,000 million of revenue and $600 million of cost of goods sold. Its gross profit is $400 million and its gross margin is 400 ÷ 1,000 = 40%.

If it raises prices by 5% and its costs stay the same, revenue grows to $1,050 million, gross profit to $450 million, and gross margin to 450 ÷ 1,050, about 42.9%.

Markup compares gross profit with cost, not with revenue. The two are easy to mix up and give different numbers for the same product.

In the example, the markup is 400 ÷ 600, about 66.7%, while the gross margin is 40%. A shop that adds 50% to its purchase price earns a gross margin of about 33.3%, not 50%.

Each margin takes away one more layer of costs. Operating margin also subtracts research, marketing and administration; net margin also subtracts interest and taxes. A company can have a high gross margin and still lose money if those other costs are larger, which is common among young software and drug companies.

The same measure, worked out from the annual reports of eight large companies. The differences come mostly from the business model, not from how well each company is run.

Software and chip designers keep most of each dollar because one more copy of a program costs almost nothing to deliver. Branded consumer goods sit in the middle. Retailers and carmakers pass most of what they collect on to suppliers and factories, so their gross margins are low by design.

• There is no single good number. Compare a company with others in its own industry and with its own history.
• A gross margin that rises over several years often means the company can raise prices or purchase and produce more cheaply.
• A gross margin that falls can mean pricing pressure from competitors or costs rising faster than prices.
• A low gross margin is not a weakness in itself. A warehouse club can earn a good return on a thin margin if goods move quickly and costs elsewhere are low.

• Companies decide differently what goes into cost of goods sold. Shipping, depreciation of factories and some staff costs can sit either above or below the gross profit line, so two companies in the same industry are not always comparable.
• Banks, insurers and many service businesses do not report a cost of goods sold at all, so the measure does not apply to them.
• It ignores every cost below the gross profit line. A company can improve its gross margin while its operating margin gets worse.
• One-off items such as inventory write-downs can move a single year.

• Gross profit as reported in the company's annual report filed with the SEC. If the report has no gross profit line, revenue minus cost of revenue, but only when that cost covers the whole cost of revenue rather than one part of it; otherwise the margin is shown as unavailable rather than estimated.
• The Piotroski F-Score uses it: one of the nine checks asks whether gross margin rose from the previous year.
• It is not used for banks, brokers and insurers.