A retail store that sells iPods that it sells for $200 that it buys for $150 earns a gross margin per iPod of $50, or 25% of the sales price. A service firm that charges $1,000 for services and pays its employee $600 to deliver those services earns a gross margin of $400, or 40% of sales. Gross margin is the total revenues recognized by the company minus the costs directly related to generating the revenues.
If a company’s gross margin as a percentage of sales fluctuates more than five percentage points in either direction from month to month, then it is likely the income statement is inaccurate. Either revenue has not been properly recognized, or the costs of goods sold are misstated. The only exception to this rule would be if the company has made a significant strategic change in its business model.
Here is an example of how the gross margin as a percentage of sales should NOT look from month-to-month:
GROSS MARGIN- Bad Example
Here is an example of how the gross margin as a percentage of sales should look from month-to-month:
GROSS MARGIN- Good Example
Our CFO consulting partners have experience helping companies understand their true gross margin. We help correctly recognize the related revenues and direct costs in the correct periods. We also help our clients to understand how their day-to-day and strategic discussions will impact their gross margin.