Relationship of Gross Margin and Depreciation by@james-johnson
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Relationship of Gross Margin and Depreciation

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If you have stepped into the arena of business and established your company, it is adamant that you must be encountering Gross Margin and Depreciation very soon.

Every company owner wants to estimate the cost of business operations and the revenue generated from it. This is the reason which makes gross margin and depreciation an essential part of business concerns.

Let’s narrow down both terms one after another and the relationship among them.

What is the Gross Margin?

The gross margin refers to the amount of remnant money after deducting the cost of products from its net sales. It is the key financial indicator that helps you in determining the gross profit of your company.

It can be easily calculated by subtracting the cost of producing the saleable products or price of rendering the services to your consumers. After these tangle manufacturing costs, the leftover money would be the amount of your gross margin.

Having said this, the gross margin tells the growth and scalability of your business. Sometimes it acts as the official profit statement of your company. 

The gross margin is directly proportional to the financial earnings of your business. Higher the gross margin, the more hike you will see in the profit graph of your business.

Gross margin = Amount of revenue minus cost of goods sold / Total revenue * 100

Related: Finance Republica helps you learn and provide accurate information.

What is Depreciation?

A depreciation is simply the reduction or decrement in the worth of your company’s assets after a particular time span. This depreciation can be due to various reasons like wear & tear, age, obsolescence of the company’s products. For example, if your business deals with the delivery of products and it purchased a truck at the rate of $30,000 for delivery purposes. The truck is expected to last 5 years and after these years it’s worth would be $5,000, which will be called its salvage value, then we can calculate straight line depreciation for this truck per year.

Straight Line Depreciation = Cost of the asset - the salvage value of an asset / (years of estimated useful life)

In the context of given example, the straight line depreciation will be,

        = $30,000 - $5,000 / 5 years 

       = $2,500 per year    

At the primary level of Accounting, any transaction that involves the process of cash or asset has its roots in the principle of demand and supply. The demand for particular products or services can be varied after years and, sometimes it can even vanish. This gives birth to the depreciation which affects those companies which used to offer such services or making those undemanding products.

Relationship of Gross Margin & Depreciation

As it has been discussed above that gross margin is the amount of profit earned after deducting the costs incurred while manufacturing the goods. Let’s elaborate it further with an example, if you are manufacturing laptops or any electronic gadget in $480 and selling it to consumers at the price of $550, the difference between both figures will clearly tell you the gross margin for that particular good. On the income statement of your business, the depreciation and gross margin both extend a different picture of your company. 

Typically, the depreciation does not include in the gross profit of the company. Although it affects the cost of the production of goods and subsequently influences the company’s gross margin. There exist some circumstances where a company needs to include amortization or depreciation in the ratio of gross margin. Depreciation causes some changes in the balance sheet and income statement; it moves the cost of assets in the column of depreciation expense on the company’s income statement.

The manual formulas and equations are very important as these are needed to calculate Gross Margin & Depreciation. If we could search online, we will find numerous online calculators like Gross Margin Calculator & Depreciation Calculator. Usually all the online available calculators use the same formula to provide output. Apart from online calculators, most banks also have provided the facility to calculate gross margin & depreciation online. Banks usually have their custom calculator to calculate gross margin, ebitda, profit margin & depreciation as per their policies. 

I hope you liked this article. Please provide your valuable feedback.


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