Gross Income vs. Gross Margins
Gross income tells you how much volume a company has transacted. Gross margin gives you an important insight into its profitability, based on the amount it typically spends to produce its products or services. A business with high annual sales will still be a poor investment if it spends more than it brings in to generate that revenue. In contrast, a company with modest sales but an impressive gross margin shows potential for being quite profitable once it builds its sales volume.
Gross Income Relevance
An impressive gross income figure reflects ongoing consumer interest in a company's products and services. A company with a high level of gross income probably has an effective marketing infrastructure and a well-established brand that translates into consistently high sales. Shrewd management may be all that is necessary to transform a business with high sales into a highly profitable company. Adjustments such as minimizing waste, making production processes more efficient and purchasing from less-expensive sources can have strong impacts on a company's earning potential, especially if its gross revenue is sufficient to generate substantial income.
Gross Income Limitations
If it costs too much to generate the level of sales that make up a company's gross income, then that business may not be a sound investment. A business that has reached the limits of its production capacity with its existing infrastructure may need to make substantial investments to become profitable. These capital improvements may not be reflected in the gross profit margin, which only captures material and labor costs, but they are nonetheless real expenses that affect overall profitability.
Gross Margin Relevance
Gross margin is a reflection of the soundness of a company's overall business model. If a company is able to create a product cheaply and sell it for a price that amply covers its variable expenses, then that company has a strong foundation that could potentially generate substantial income once the business generates more revenue. A healthy gross margin may be more reflective of a company's potential than of its current financial well-being. Nonetheless, potential for future profit is an essential criteria when making investment decisions.
Gross Margin Limitations
A company's gross margin only tells part of the story about its financial viability. Because gross margin only reflects variable expenses, or costs directly related to production and sales, it can skew information about overall profitability. For example, if a company is paying unsustainably high rent, then it won't be profitable even if it has a healthy gross margin. In addition, if a business never manages to build its sales volume to generate sufficient gross income, a high gross margin will never translate into substantial income.
Devra Gartenstein is an omnivore who has published several vegan cookbooks. She has owned and run small food businesses for 30 years.