Gross Profit Margin Formula (Table of Contents)
Gross Profit Margin Formula
At every level, the investors need to investigate. She needs to know how every aspect of the business is doing. When an investor looks at the income statement, it isn’t enough to check one profitability ratio like net profit margin. It’s equally important to look for other profitability ratios.
One of the most significant of all is a gross margin.
- Gross margin dictates how much profit a firm makes just by deducting the cost of goods sold from the revenue.
- Gross margin doesn’t take any other expenses into account except the cost of goods sold.
Here’s the gross profit margin formula –
Example of Gross Profit Margin Formula
Let’s take a practical example to illustrate gross profit margin formula.
Honey Chocolate Ltd. has the following information in its income statement –
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- 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 Gross Profit margin Ratio, we can say that the gross profit 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.
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Gross Margin of Colgate
Shipping and handling costs may be reported in 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 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
Explanation of Gross Profit Margin Formula
In 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 the net sales. The next item in the income statement is the costs of goods sold. When we deduct the costs of goods sold from the net sales, we get the gross profit of the company for the year.
- The second component of the gross profit 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 profit margin Ratio.
Use of Gross Profit Margin Formula
Profitability is an important factor to consider for investors. Investors look at mainly net profit margin along with gross margin. 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, 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 Gross Profit Margin Calculator.
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Gross Profit Margin Formula in Excel (with excel template)
Let us now do the same example of gross profit margin calculator.
This is very simple. You need to provide the two inputs of Gross Profit and Revenue.
You can easily calculate Gross Margin in the template provided.
You can download this gross profit margin template here – Gross Profit Margin Excel Template
Gross Profit Margin Formula Video
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