Gross margin is a company's gross profit in a given period divided by its revenue during that period. While operating margin and net margin are also useful ratios, gross margin is one of the most critical tools in evaluating the financial health of a company. Weighted gross margin takes into account variance in margins across a mix of products in your portfolio.
Calculate Gross Profit
Gross profit is typically calculated in the first section of a company's periodic income statement. To calculate your gross profit, subtract cost of goods sold for the period from revenue for that same period. If your business generated $400,000 in revenue for a year and had $200,000 in COGS, your gross profit is $200,000.
Divide gross profit by revenue. Gross margin is a ratio that demonstrates the efficiency with which you convert revenue into gross profit. A gross profit of $200,000 divided by periodic revenue of $400,000 equals 0.50.
Express your ratio as a percentage. Gross margin ratios represent a percentage of revenue that converts to gross profit. To convert a ratio of 0.50 to a percentage, multiply it by 100. Thus, your gross margin is 50 percent.
Calculated Weighted Average Gross Margin
Calculate the gross margin for each product category. If Product A accounts for 30 percent of the $400,000 revenue, it generated $120,000. If its COGS was $80,000, its gross margin was $40,000 divided by $120,000, or 33 percent. Assume Product B accounted for 60 percent of sales and its margin was 40 percent, and Product C accounted for 10 percent of sales and its margin was 50 percent.
Multiply each product category's margin by its sales mix. For Product A, 33 percent times 66.7 percent equals 0.20 or 20 percent. For Product B, 40 percent times 60 percent equals 24 percent. For Product C, 10 percent times 50 percent equals 5 percent.
Add the product mix together. When you add 20 plus 24 plus 5, you get a weighted average gross margin of 49 percent. A weighted average gross margin calculated slightly below the conventional margin suggests you sell a higher volume of goods with slightly lower margins.
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