Gross margin is the difference between net sales and the cost of goods sold (COGS). It is, essentially, the money retained by a company after incurring the direct costs associated with supplying the goods or services it sells.
A company with a high gross margin retains more capital, which it can use to pay other costs or meet debt obligations. Net sales are the gross revenue less returns, allowances, and discounts.
The formula for Gross Margin is:
Gross Margin = Net Sales - COGS
In order to evaluate how their production costs relate to their revenues, companies use gross margin, gross profit, and gross profit margin. When a company's gross margin is declining, it may try to cut labor costs or look for cheaper suppliers of materials.
In addition, it may decide to raise prices as a revenue-increasing measure. Margin of gross profit can also be used to compare companies of different market capitalizations or to assess company efficiency.