What is Gross Profit Margin?
Gross Profit Margin is the ratio that calculates the profitability of the company after deducting the direct cost of goods sold from the revenue and is expressed as a percentage of sales. It doesn’t include any other expenses into account except the cost of goods sold.
Gross Profit Margin Formula
Here’s the formula –
In the gross profit margin formula, there are two components.
- The first component is gross profit. To calculate gross profit, we need to start with the gross sales. Gross sales are the first item in an income statement. We deduct the sales returns/sales discounts from gross sales and we get net sales. The next item in the income statement is the costs of goods sold. When we deduct the costs of goods sold from net sales, we get the gross profit of the company for the year.
- The second component of the gross margin ratio is revenues. Here revenues mean the total sales value of goods sold. When we multiply the sales price for each of the numbers of goods sold, we get the total revenue. Since “sales returns” or “sales discounts” can’t be included in the total sales value, we need to deduct these items from the total sales value. And by deducting these, we get “net sales”. And here we will consider “net sales” as the second component of the gross margin ratio.
Examples
Honey Chocolate Ltd. has the following information in its income statement –
- Net Sales – $400,000
- Cost of Goods Sold – $280,000
Find out the gross margin of the year.
First of all, we need to find out the gross profit of Honey Chocolate Ltd.
Here’s the calculation.
- Gross Profit = (Net Sales – Cost of Goods Sold) = ($400,000 – $280,000) = $120,000.
Using the gross profit margin formula, we get –
- Gross Margin = Gross Profit / Revenue * 100
- Or, Gross Margin = $120,000 / $400,000 * 100 = 30%.
- From the above calculation for the Gross margin, we can say that the gross margin of Honey Chocolate Ltd. is 30% for the year.
To interpret this percentage, we need to look at other similar companies in the same industry.
Gross Margin of Colgate
Let us calculate Colgate’s Gross Margin. Colgate’s Gross Margin = Gross Profit / Net Sales.
Cost of Operations include the Depreciation related to manufacturing operations (Colgate 10K 2015, pg 63)
Shipping and handling costs may be reported in the Cost of Sales or Selling General and Admin Expenses. Colgate reported these as a part of Selling General and Admin Expenses. If such expenses are included in the Cost of Sales, then the Gross margin of Colgate would have decreased by 770 bps from 58.6% to 50.9% and decreased by 770bps and 750 bps in 2014 and 2013 respectively.
source: – Colgate 10K 2015, pg 46
Uses
Profitability is an important factor to consider for investors. Investors look at mainly net profit margin along with gross margin. The gross profit margin calculator is useful to investors because by calculating the percentage, they can easily compare it with other similar companies.
Comparing the gross profit percentage of all similar companies in the same industry provides the investors with the knowledge of whether the gross profit of the target company is healthy or not. Higher the gross profit percentage, the better the company’s overall health and profitability. However, every investor should look at all the financial ratios before coming to any conclusion.
Gross Profit Margin Calculator
You can use the following calculator.
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Calculate Gross Profit Margin in Excel
Let us now do the same example of a gross margin calculator.
This is very simple. You need to provide the two inputs of Gross Profit and Revenue.
You can easily calculate the Gross Margin in the template provided.
You can download this template here – Gross Profit Margin Excel Template
Gross Profit Margin Video
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