Understanding Gross Margin & Profit: A Guide to Calculation and Analysis

A company with high sales may still be unprofitable if it also has a high cost of goods sold.

If you can properly evaluate the trend in a company's gross margins, you can more accurately forecast the future of the company's profitability for investing. A high volume of sales isn't enough for a company to be successful. If the company also has a high cost of goods sold, its earnings are reduced and may even be negative. Calculating a company's gross margin and gross profit percentage better indicate the profits of a company. Comparing these figures over different time periods helps you identify the company's earnings trend.

Step 1

Look up the company's total revenues on the income statement from the first date you're trying to compare.

Step 2

Look up the company's total cost of goods sold on its income statement from the first date you're trying to compare.

Step 3

Subtract the cost of goods sold from the total revenues to calculate the company's gross profit.

Step 4

Divide the gross profit by the firm's total revenues and multiply the result by 100. This calculates the company's gross margin, also known as the gross profit percentage.

Step 5

Complete this same calculation using the income statement published on the second date in your comparison.

Step 6

Subtract the gross margin of the first date from the gross margin of the second date. Divide the result by the first date's gross margin and multiply the result by 100. This calculates the percentage change in gross margin over that time period.

Example: Last year a company had a gross margin of 20 percent. Today the gross margin is 24 percent. What is the change in gross margin?

(24 - 20) / 20 = 4 / 20 = 0.20 = 20 percent

The gross margin has increased by 20 percent over the past year.