Question

All else being equal, an increase in a company's cost of goods sold will increase its gross margin.

True or False

Answer 1

The statement is False.

Gross Margin is defined as Gross Profit / Revenue.

Gross Profit = Revenue - Cost of Goods Sold

An increase in Cost of Goods Sold, will decrease the Gross Profit and hence the Gross Margin, all else being equal.

Eg. Let's say Revenue = $100, Cost of Goods Sold = $50

So, Gross Profit = Revenue - Cost of Goods Sold

Goss Profit = 100 - 50 = $50

Gross Margin = 50/100 = 0.5 or 50%

Now, if we increase the Cost of Goods Sold to $60, keeping the revenue constant at $100, the Gross Profit reduces to $40 ------------------------- 100 - 60

So, the new Gross Margin = 40 / 100 = 0.4 or 40%.