Gross Profit Margin

Gross Profit Margin Meaning

The gross profit margin is the ratio that calculates the company’s profitability after deducting the direct cost of goods sold from the revenue and is expressed as a percentage of sales. It does not include any other expenses except the cost of goods sold.

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The discussion of what a good gross profit margin percentage depends on the industry of the business or the nature of sales. However, as a rule of thumb, it is considered that a 10% gross profit margin is good, 5% is low, and Over 10% is considered high retention of gross profit.

Gross Profit Margin Explained

Gross profit margin is the amount retained by an organization after its sales. The gross profit percentage gives the company an idea of its costs and their profit percentage. It is an important metric for them to keep a close eye on to ensure their profitability is in check and its growth plan can be curated accordingly.

In the gross profit margin formulaProfit Margin FormulaProfit Margin can be calculated by dividing the gross profit by revenue. Profit margin formula measures the amount earned (earnings) by the company with respect to each dollar of the sales generated. read more, there are two components.

Explanation of Gross Profit Margin in Video

Formula

The formula to calculate gross margin and be able to carry out gross margin interpretation is-

Gross Profit Margin Formula = Gross Profit/ Revenue

Examples

Let us understand the concept of finding gross profit percentage with the help of a couple of examples.

Example #1

Honey Chocolate Ltd. has the following information in its income statement: –

• Net Sales – $400,000
• Cost of Goods Sold – $280,000

Find out the year’s gross margin.

First, we need to find out the gross profit of Honey Chocolate Ltd.

Here is 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.

Example #2

Let us calculate Colgate’s gross margin. Colgate’s Gross Margin = Gross Profit / Net Sales.

Cost of operations includes the depreciationDepreciationDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year. read more related to manufacturing processes (Colgate 10K 2015, pg. 63).
Shipping and handling prices may be reported in the cost of sales or selling general and admin expensesSelling General And Admin ExpensesSelling, general and administrative (SG&A) expense includes all the expenses incurred in the selling of the products of the company whether direct or indirect along with the entire general and the administrative expenses during an accounting period under consideration such as advertisement expenses, sales promotion expenses, marketing salaries, etc.read more. Colgate said these as a part of selling general and admin expenses. Suppose charges are included in the cost of salesThe Cost Of SalesThe costs directly attributable to the production of the goods that are sold in the firm or organization are referred to as the cost of sales.read more, the gross margin of Colgate decreased by 770 bps from 58.6% to 50.9%. It may fall by 770bps and 750 bps in 2014 and 2013, respectively.

source: – Colgate 10K 2015, pg 46

Calculator

You can use the following calculator: –

Excel Calculation

Let us now do the same example of a gross margin calculator.

It is very simple. You need to provide the two inputs of gross profit and revenue.

Then, you can easily calculate the gross margin in the template provided.

You can download this template here – Gross Profit Margin Excel Template.

Importance

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 they can easily compare it with other similar companies by calculating the percentage.

Comparing the gross profit percentage of all similar companies in the same industry provides the investors with the knowledge of whether the target company’s gross profit is healthy. The better the gross profit percentageGross Profit PercentageGross profit percentage is used by the management, investors, and financial analysts to know the economic health and profitability of the company after accounting for the cost of sales. Gross profit percentage formula = Gross profit / Total sales * 100% read more, the better the company’s overall health and profitability. However, every investor should look at all the financial ratiosFinancial RatiosFinancial ratios are indications of a company's financial performance. There are several forms of financial ratios that indicate the company's results, financial risks, and operational efficiency, such as the liquidity ratio, asset turnover ratio, operating profitability ratios, business risk ratios, financial risk ratio, stability ratios, and so on.read more before concluding.

Frequently Asked Questions (FAQs)

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