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Gross Profit is the different between the sale prices and the cost of buying or producing the goods. It is calculated as
Gross Profit = Revenue - Cost of Goods Sold
Gross Profit is the numerator in the calculation of Gross Margin:
= Gross Profit / Revenue
= (Revenue - Cost of Goods Sold) / Revenue
A positive Gross Profit is only the first step for a company to make a net profit. The gross profit needs to be big enough to also cover related labor, equipment, rental, marketing/advertising, research and development and a lot of other costs in selling the products.
Gross Profit = Revenue
- Cost of Goods Sold
Warren Buffett believes that firms with excellent long term economics tend to have consistently higher margins.
Durable competitive advantage creates a high Gross Margin
because of the freedom to price in excess of cost. Companies can be categorized by their Gross Margin
1. Greater than 40% = Durable competitive advantage
2. Less than 40% = competition eroding margins
3. Less than 20% = no sustainable competitive advantage
Consistency of Gross Margin
, Cost of Goods Sold
, Gross margin