Profitability ratios - Gross Margin

Gross margin, gross profit margin or gross profit rate is the difference between the sales and the production costs excluding overhead, payroll, taxation, and interest payments. Gross margin can be defined as the amount of contribution to the business enterprise, after paying for direct-fixed and direct-variable unit costs, required to cover overheads (fixed commitments) and provide a buffer for unknown items. It expresses the relationship between gross profit and sales revenue. It is a measure of how well each rupee of a company's revenue is utilized to cover the costs of goods sold.


It can be expressed as :-
Gross Margin = Net Sales - Cost of Goods Sold + Annual Sales Return
Or,
Gross Margin = Gross Profit / Net Sales
Gross margin Percentage = Revenue - Cost of Goods Sold / Revenue
Note:- Companies with higher gross margins will have more money left over to spend on other business operations, such as research and development or marketing. Companies with the higher Gross Margin Percentage, the more the company retains on each rupee of sales to service its other costs and obligations.


Illustration:-
This is the 2nd Quarter Result of Reliance Industries Limited for session 2010 -2011 

From this Result, we can take the relevant information to calculate the Gross Margin :-
Gross Profit for 2nd Quarter 2010 =  Rs. 6149 cr.
Net Sales for 2nd Quarter 2010 =  Rs. 57479 cr
So, Gross Margin = Gross Profit / Net Sales
Gross Margin = 6149 / 57479 = 0.10


Analysis:-


So, Gross Margin is 0.10 means for every rupee generated in sales, the company has Rs. 0.10 paise left over to cover basic operating cost & Profit for 2nd Quarter 2010 -2011.