How is gross margin on a line item calculated?

• A. Gross margin percentage = Cost of goods / Selling price
• B. Gross margin percentage = (Selling price - Cost of goods) / Selling price
• C. Gross margin percentage = Selling price - Cost of goods
• D. Gross margin percentage = Selling price / Cost of goods

Answer: (B)

Gross margin percentage shows how much of each dollar of selling price remains as gross profit after covering the cost of goods. To get a percentage, you take the difference between selling price and cost of goods, then divide by the selling price. This yields the portion of the selling price that is gross profit. For example, if something sells for 100 and costs 60, the gross margin percentage is (100 - 60) / 100 = 0.40, or 40%.

The other forms mix up what’s in the numerator or denominator: using cost of goods in the numerator gives a cost-based ratio, which isn’t the margin percentage; just selling price minus cost gives the dollar amount of gross margin, not a percentage; and selling price divided by cost of goods isn’t a standard margin measure.