What is Gross Margin?
Gross margin is the profit (%) you gain out of the sale price of a certain product. It is calculated by subtracting the cost price from the sale price and dividing the result by the sale price, then multiplying by 100 to get the percentage.
Gross Margin Formula
Gross Margin (%) = (Sales Price – Cost) ÷ Sale Price x 100
Example: We bought a product at 40$ and sold it at 100$
Gross Margin = (100$-40$) ÷ 100$ x 100 = 60%
Difference Between Gross Profit & Gross Margin
Gross profit is a dollar amount and gross margin is when you divide this amount by the sale price, and then multiply this by 100 to get the percentage.
Example: We bought a product at 40$ and sold it at 70$
Gross Profit = 70$ -40$ = 30 $
Gross Margin = (70$-40$) ÷ 70$ x 100 = 42.9%
Gross Margin Formula in Excel
You can create this formula in excel by entering the function in the picture below. If you want to show % sign then you can format the cell as “percentage” but in this case remove the “*100” from the formula.
You can also download the gross margin excel calculator, with other retail math calculators and cheat sheet from below.
Intake Margin vs. Realized Margin
Here is the part where it gets confusing, especially when you are planning for your sales budget or buying budget.
Your gross margin for the same product will differ based on the amount of discount you applied to it during the sales process. You should be able to differentiate between intake margin vs realized margin, and both of them are types of gross margin.
Intake Margin
Intake margin is the margin you get when you sell the product at full price, without any discount. It is called “intake” because this is the initial price you have set the product at when you first received it.
Realized Margin
Realized margin is the actual gross profit margin you realize at the end from the product, after exposing it to different discounts and markdowns.
Example
Let’s look at an example with the same prices we used before
If the product cost me 40$ and will be priced at 100$ my gross margin is 60%.
This is called intake margin; i.e the margin at which I initially priced the product at when it arrived.
If I apply 50% discount this month, so it will sell at 50$, my gross margin for the product will be 20% as per the same formula
(Sale Price – Cost Price ) ÷ Sale Price x 100
(50$-40$) ÷ 50$ x 100 = 20%
In this case my gross margin is NOT equal to my intake margin and is also called realized margin
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Why Is This Important ?
Budgeting
This is very important for the retail budgeting process, whether you are budgeting your sales, buying or the final P&L budget.
You will need to include the profit you expect to realize from your sales in each type of these budgets, and as we have shown with the formulas above there is a big difference in profitability between 60% & 20%.
If you make your entire planning for the year based on how much you bought the product and how much you initially priced it at (i.e intake margin), this could be a costly mistake. You will almost never have a full year going without some sort of discount to promote your products or move the unwanted ones out of the door.
That’s why you will find by practice that it is actually the realized margin that matters. This is the margin that will appear in your P&L at the end.
Read More: P&L Management
Buying
The intake margin is still important when it comes to planning your buying budget, because it determines the cost you are going to pay for purchasing the goods (COGS).
Even in the buying budget you are still going to need the realized margin to determine the cost of products that you have sold or planning to sell. The difference between both will determine your level of markdowns (discounting)
Confusing between the two types in this budget will result in wrong planning and consequently wrong buying.
Read More: Open to Buy: The Complete Guide
Pricing
Another time you will need to differentiate between intake margin & realized margin is when you initially set your prices. In order to get the margin that you want at the end of the year (realized margin), you will have to price at a level (intake margin) that takes into consideration all the price skimming and markdowns that you will run later on.
- Factors Affecting Retail Prices
- The Different Pricing Methods
- Pricing a Product Portfolio
Access our members area and use our markdown planning tool to determine the intake margin you need to price at, based on your level & frequency of discounting. Combine it with our pricing blueprint & pricing course which show you how to price your entire product portfolio to get the most margins out of each product.
How to Plan for Realized Margin
Your realized margin will depend on the amount of markdowns and discounts that you expect to expose this product to throughout the planned period. Determining the level of discount and knowing your intake margin will help you plan for the expected realized margin.
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More Resources
Thank you for reading this article on Gross Margins. We recommend the below free resources as well:
Read more articles on Pricing or join the academy and take the different courses that will show you how to set the right pricing strategy for your business, and get the best margins out of the different products in your portfolio.