Term · Profitability & Growth

Gross margin

Core

In briefGross margin expresses gross profit as a percentage of revenue and is the earliest profitability indicator in the income statement. It shows pricing power independently of fixed costs.

Definition

Gross margin relates gross profit after directly attributed cost of sales to revenue. The allocation of costs can vary between companies and industries.

How it is calculated

Formula. Gross margin = gross profit ÷ revenue × 100.

Why it matters for small caps

The earliest profitability indicator in the income statement – it shows pricing power independently of fixed costs.

Common misreadings

A high gross margin is automatically equated with high profitability. Selling, development and administrative costs as well as capital intensity are left out of account.

In the process

→ Used in Step 3 – Financial traffic-light

Frequently asked

What is the gross margin?

It indicates what share of revenue remains after the direct cost of sales. It is expressed as a percentage.

What is the gross margin used for?

It helps compare pricing and direct cost structure over time and between companies. Because fixed costs are left out, it isolates the pure trading spread.

Why does a high gross margin not automatically mean high profitability?

Sales, administration, development and capital intensity are not taken into account. A company with a high gross margin can still be loss-making on the bottom line.