Gross margin is the profit you make when you subtract the direct costs of producing your product from the price you sell it for.
Example: Gross Sandwich Gross Margins
Say you have a food cart at the park, and decide to sell really gross sandwiches. For example, a sandwich with pretzel, catsup and ice cream (pastrami optional).
Each pretzel, catsup and ice cream sandwich sells for $5, and for some reason, you are selling lots of them today!
The cash is rolling in.. so it seems you’ll make a lot of money. And since your family lent you the food cart, you don’t have to pay for that.
But how much money are you really making per sandwich?
This is where gross margins come in. Your gross margin is the price you sell your product for, minus the direct costs of producing that product… in this case, the gross ingredients.
So for every $5 sandwich you sell, if you have to buy $1 worth of ice cream, $1 worth of pretzels, and 50 cents of catsup, your gross margin is $2.50, or $5 minus your total ingredient costs.
Since gross margin (sometimes called gross profit) is normally expressed as a percentage, your gross profit on these gross sandwiches would be 50% ($2.50 is 50% of $5). That’s pretty good! Especially for a sandwich that gross…
This is a silly – and simple – example. Some companies include other direct costs in their gross margin calculations – like labor and credit card fees, for example, not just materials or ingredients.
But you get the idea.