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In: Accounting

What is gross margin? How is it calculated? Why might management be interested in the use...

What is gross margin? How is it calculated? Why might management be interested in the use of the tool for analyzing accounting information? Using a bit of research, which industry presents a notoriously low gross margin percentage, and conversely, name an industry that traditionally experiences a high gross margin percentage.

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Expert Solution

Solution:-

1. What is gross margin:-

Gross margin is net sales less the cost of goods sold. The gross margin reveals the amount that an entity earns from the sale of its products and services, before the deduction of any selling and administrative expenses. The figure can vary dramatically by industry. For example, a company that sells electronic downloads through a website may have an extremely high gross margin, since it does not sell any physical goods to which a cost might be assigned. Conversely, the sale of a physical product, such as an automobile, will result in a much lower gross margin.

The amount of gross margin earned by a business dictates the level of funding left with which to pay for selling and administrative activities and financing costs, as well as to generate a profit. It is a key concern in the derivation of a budget, since it drives the amount of expenditures that can be made in these additional expense classifications.

2. How is it calculated:-

As just noted, the formula for the gross margin is net sales less the cost of goods sold. It is better to use net sales than gross sales, since a large number of deductions from gross sales could skew the results of the calculation. Gross margin is frequently expressed as a percentage, called the gross margin percentage. The calculation is:

For example, a company has sales of $1,000,000 and cost of goods sold of $750,000, which results in a gross margin of $250,000 and a gross margin percentage of 25%. The gross margin percentage may be stated in a company's income statement.

3. Why might management be interested in the use of the tool for analyzing accounting information:-

The gross margin or gross profit is the sales minus the cost of sales. Or, put another way, the excess of net sales over the cost of goods sold. Usually this is expressed as a percentage by dividing the gross margin by the net sales. This is important for business owners to watch. A small percentage fluctuation in gross profit can cause a large dollar change in net income.by analyzing this type of information the company may see the gross margin is lower than desired and need to increase its selling prices or decrease its cost of goods sold.

Management might be interested in the use of a tool for analyzing accounting informationbecause it will make it easier for them to view the overall business transactions that are made over a specific time period. It would also allow them to effective business decision by using accurate information in a timely manner.

4. Using a bit of research, which industry presents a notoriously low gross margin percentage, and conversely, name an industry that traditionally experiences a high gross margin percentage:-

The following industries have some of the lowest gross margin percentages:

  • Food/beverage stores,
  • building construction,
  • wholesale trade,
  • car dealers and
  • gas stations.

The following industries have some of the highest gross margin percentages:

  • legal services,
  • healthcare,
  • banking,
  • hotels, and
  • accounting services.


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