Gross margin: definition and calculation

Gross margin is the difference between revenue from the sale of goods and variable costs. Sometimes the definition of "marginal revenue" is used. This calculation indicator does not allow to characterize the financial state of the company, but it is necessary in the calculation of many indicators.

Thus, the ratio of marginal revenue to the amount of revenue received from the sale of goods determines the gross margin ratio. Variable costs include expenses for materials and raw materials for the main production, sales costs, wages for the main production workers, etc.

The costs (variables) are directly proportional to the volume of production. The enterprise is interested in that the costs per unit of output are lower, as it allows to get more profit. When the volume of output of goods varies, the costs are correspondingly increased (reduced), but per unit of output they have a constant unchanged value.

Revenues from sales are calculated from the records of all receipts that are associated with settlements in kind or in cash, for goods, services, work or property rights.

Gross margins show what contribution the enterprise has made to profit and cover fixed costs. The gross margin is determined in two ways.

In the first case, any direct costs or variable costs, as well as part of the overhead (total production) costs, that relate to the variables and depend on the volume of production, are subtracted from the company's revenue received for the goods sold. The second way gross margin is calculated by adding profits and constant costs to the company.

There is also such a thing as the average size of the gross margin. In this case, the difference between the price and the average costs (variables) is taken. This category shows how a unit contributes to making a profit, and how it covers fixed costs.

Under the norm of gross margin understand the share of the amount of marginal revenue in revenue, or for an individual product - the share of income in the price of the product. The given indicators allow to solve various industrial tasks. For example, with the help of the described coefficients it is possible to determine profit at different volumes of production. To better understand the economic meaning of the indicator "gross margin", we can consider the following task.

Suppose a manufacturing company produces and sells goods, for production and marketing of which has average variable costs of $ 100 per unit. The very same product is sold at a price of 150 rubles per unit. The constant costs of the company are 150 thousand rubles a month. It is necessary to calculate what profit a firm will have in a month if sales are 4000 units, 5000 units, 6000 units.

At the first stage of the decision it is necessary to determine what value the gross margin and profit will take for each option, since the fixed costs do not depend on the volume of production. The profit of the enterprise can be determined for any volume of production. For this, it is necessary to multiply the average gross margin by the volume of production, as a result, the total amount of marginal revenue will be obtained.

Further from the total value it is necessary to take away fixed costs. As a result, it turns out that the profit of the enterprise will be 50, 100 and 150 thousand respectively for each case.

From the example shown, you can see that the increase in profit can be achieved by increasing gross margin. To do this, reduce the sales price and increase the sales volume, or reduce the fixed costs and increase sales, or proportionally change costs (fixed and variable) and output.