When a company sells a product, there are almost always costs involved that reduce profits. There's the direct cost of buying or manufacturing products it sells. In addition, indirect sales costs include items such as employee salaries, overhead and sales commissions, which must be subtracted to determine a company's net income. These costs are reflected in the company's income statement. From the income statement, you can calculate both gross and net margin, expressing sales costs as a percentage of company sales.
Gross Margin Formula
Sales costs as a percentage of sales are traditionally presented in terms of gross margin and net margin. Gross margin reflects the cost of goods sold before other sales costs are subtracted. The formula used to calculate gross margin is gross profit, which you can find in the top section of the company's income statement, divided by total sales or revenue. For example, if a company has a gross margin of 25 percent, it earns a 25-percent gross profit on each good it sells. Stated another way, its sales cost for each unit of goods it sells is 75 percent.
Before you can calculate the total sales-cost percentage for a company, you first need to know the company's net income. Net income is gross profit less all other sales costs plus any additional company revenue, such as interest earned on investments. You can find the company's net income at the bottom of the income statement.
Net margin represents a more realistic way to measure a company's sales-cost percentage, since it includes all costs involved, not just the cost of goods sold. The formula for net margin is net income divided by total sales revenue. For example, if a company has a net margin of 10 percent, it means it earns an average profit of 10 percent on each good it sells. Stated another way, its average sales cost involved in selling a product is 90 percent.
Changing Sales-Cost Percentages
The sales cost percentage for companies can change over time. Profit margins increase or decrease when factors such as materials or labor costs increase or decrease. For example, when fuel costs rise, profit margins in the airline industry fall, meaning selling costs increase. Companies can respond to lowering profit margins by increasing the price they sell their products for; however, if they do, they potentially risk losing sales.
Donald Harder has been writing financial-related articles since 2000 when he founded the firm Securities Research Services. He has worked as a speech writer for the U.S. Department of Justice and written white papers and studies for the U.S. Department of Housing and Urban Development. Harder holds a Master of Arts in international affairs from George Washington University.