Gross Profit Margin

What is the 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 for the cost of goods sold.

Gross Profit Margin Formula

Here’s the formula –

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.

• The first component is gross profit. To calculate gross profit, we need to start with the gross salesThe Gross SalesGross Sales, also called Top-Line Sales of a Company, refers to the total sales amount earned over a given period, excluding returns, allowances, rebates, & any other discount. read more. 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 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 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. 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 coming to any conclusion.

Gross Profit Margin Calculator

You can use the following calculator.

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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This has been a guide to Gross Profit Margin and its definition. Here we discuss the formula to calculate gross margin along with practical examples, its uses, and interpretation. Here are the other suggested articles –

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