What is gross margin?

Gross margin is defined as the difference between sales revenue and the cost of goods sold (COGS). This metric is crucial for assessing a company's financial health because it reflects the portion of sales that exceeds the costs directly associated with producing the goods sold by the company. Gross margin allows businesses to understand how efficiently they are producing goods relative to their sales, which is foundational for making pricing decisions and controlling production costs.

In this context, focusing on the sales revenue gives insight into the company's income-generating ability, while subtracting the cost of goods sold highlights how much profit remains after accounting for direct production costs. This profit is vital for covering other operating expenses, taxes, interest, and ultimately contributing to net income.

Calculating gross margin helps businesses gauge their pricing strategies and operational efficiency, making it an essential measure in financial analysis. In contrast, measures related to total revenue minus total expenses or profits from total assets do not directly illustrate the profitability derived from core business operations related to sales and COGS. Similarly, amounts received from investors pertain to financing rather than operational profitability, further distinguishing gross margin as a critical indicator of a company's operational success.