Why is it important for a business to have a high gross margin?

• A. It shows that the company is minimizing its tax liability.
• B. It means the company has higher total sales revenue, regardless of costs.
• C. It ensures that all liabilities are paid off immediately.
• D. It indicates the company is generating more profit from each dollar of net sales, allowing more funds to cover operating expenses and generate net income.

Answer: (D)

Verified step by step guidance

1. Understand the concept of gross margin: Gross margin is the percentage of revenue remaining after deducting the cost of goods sold (COGS). It is calculated using the formula: Gross Margin = ((Net Sales - COGS) / Net Sales) × 100.
2. Recognize the importance of gross margin: A high gross margin indicates that a company is efficiently managing its production costs relative to its sales revenue, leaving more funds available for operating expenses and net income.
3. Clarify the incorrect options: A high gross margin does not directly minimize tax liability, guarantee higher total sales revenue, or ensure immediate payment of liabilities. These are unrelated to the concept of gross margin.
4. Focus on the correct interpretation: A high gross margin means the company is generating more profit from each dollar of net sales, which can be used to cover operating expenses, invest in growth, and generate net income.
5. Relate gross margin to financial health: Businesses with a high gross margin are better positioned to sustain operations, invest in future opportunities, and weather economic challenges, making it a critical metric for financial performance.