Gross margin is one of several profit margin measures. It is the amount of contribution to the business after paying for the costs that it incurs for producing its products and/or services.

Basically,

Gross Margin = (Revenue – Cost of Goods Sold)/Revenue

Cost of goods sold includes variable and fixed costs directly linked to the product, such as material and labor. It does not include indirect fixed costs like office expenses, rent, administrative costs, utilities and etc.

For example, if a product costs your company $100 to make and if revenue is $150, then

Gross Margin = ($150 – $100)/$150 = 33%

Gross margin is a good indication of how profitable a company is at the most fundamental level. Basically, higher gross margins for a manufacturer reflect greater efficiency in turning raw materials into income.

Larger gross margins are generally good for companies. It shows that they will have more money left over to spend on other business operations, such as research and development or marketing. As such, investors tend to pay more for businesses that have higher gross margin than their competitors, as these businesses should be able to make a better profit as long as overhead costs are controlled.