What is included in gross margin?

Gross margin is a financial metric that evaluates the proportion of revenue that exceeds the cost of goods sold (COGS). It essentially represents the portion of sales revenue that is available to cover operating expenses and profit after accounting for the direct costs associated with producing goods or services.

The correct answer mentions gross profit divided by revenue, which accurately reflects the concept of gross margin. Gross profit is calculated as total revenue minus the costs directly tied to the production of goods sold. By dividing gross profit by total revenue, you determine the gross margin as a percentage, highlighting how much of each dollar of revenue is retained as gross profit.

This ratio is critical for assessing a company's financial health and operational efficiency, as a higher gross margin indicates that the company retains more per dollar of sales, which can be used to cover other expenses and ultimately contribute to net income. Understanding gross margin helps compensation professionals evaluate how well a company is managing its production costs relative to its sales, thereby influencing strategic compensation decisions tied to financial performance.