# Gross Profit Margin

Reviewed byDheeraj Vaidya, CFA, FRM

## 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.

For eg:
Source: Gross Profit Margin (wallstreetmojo.com)

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.

### Key Takeaways

• The gross profit margin is the ratio that determines the company’s profitability after writing off the direct cost of goods sold from the revenue.
• It may be expressed as a percentage of sales. Therefore, it does not involve other expenses except the cost of goods sold.
• The gross profit margin formula includes gross profit and revenues.
• It is helpful to investors to compare it with similar companies by calculating the percentage

### 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.

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### 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 related to manufacturing processes (Colgate 10K 2015, pg. 63).
Shipping and handling prices may be reported in the cost of sales or . Colgate said these as a part of selling general and admin expenses. Suppose charges are included in , 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: –

 Gross Profit Revenue Gross Profit Margin Formula =

Gross Profit Margin Formula ==
 Gross Profit X 100 Revenue
 0 X 100 = 0 0

### 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 , the better the company’s overall health and profitability. However, every investor should look at all the  before concluding.

What does the gross profit margin show?

The gross profit margin indicates what one can do business with after paying for the direct cost, including labor, materials, and other direct production costs. It is one of three significant profitability ratios. In addition, the others are operating profit margin and net profit margin.

How to improve gross profit margin?

Improve gross profit margin through consolidating the offer, renegotiating with suppliers for exceptional deals, upselling to the current clients, and enhancing capability and output.

Why gross profit margin is essential?

It is essential when checking a business’s profitability and financial performance. The gross profit helps you understand the costs needed to generate revenue. Gross profit margin is necessary for several reasons
a Measure of efficiency
b Profitability assessment
c Benchmark and comparison
d Pricing and cost management
e Financial planning

Should gross profit margin be high or low?

The higher gross profit margins show more profitable companies. Moreover, it shows that the company needs to spend more revenues on production expenses such as salaries and raw materials.

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