Calculate Gross Profit Margin
Gross profit is a fairly simple comparison of the cost of the goods your company sells to the income derived from those goods. Gross profit margin is the ratio of gross profit to total revenue expressed as a percentage. Gross profit margin is a quick yet useful way to meaningfully compare your company to competitors or average industry values. It can also be used to compare your company's current state to its past performance, especially in markets where the price of your goods can fluctuate significantly.
Contents
Steps
Calculating Gross Profit Margin
- Look up Net Sales and Cost of Goods Sold. The company's income statement lists both values.
- Gross Profit Margin = (Net Sales - Cost of Goods Sold) ÷ Net Sales.
- Example. A company makes $4,000 selling goods that cost $3,000 to produce. Its gross profit margin is <math>\frac{4000 - 3000}{4000} = \frac{1}{4}</math>, or 25%.
Understanding the Terms
- Understand Gross Profit Margin. The Gross Profit Margin (GPM) is the percentage of revenue a company has left over after paying direct costs of producing goods. All other expenditures (including shareholder dividends) must come out of this percentage. This makes the GPM a good indicator of profitability.
- Define Net Sales. A company's net sales equal its total sales minus returns, allowances for damaged merchandise, and discounts. This is a more accurate measure of incoming money than total sales alone.
- Measure Costs of Goods Sold. Abbreviated COGS, this figure includes the cost of materials, labor, and other expenses directly related to the production of goods or services. It does not include costs of distribution, labor that does not go into goods production, or other indirect costs.
- Avoid confusing Gross Profit with GPM. The Gross Profit equals the Net Sales minus the Cost of Goods Sold. This is expressed in dollars or other units of currency. The formula above converts Gross Profit to GPM, a percentage, for easy comparison with other companies.
- Understand why these figures are important. Investors look at Gross Profit Margin to see how efficiently a company can use its resources. If one company has a GPM of 10% and a second company has a GPM of 20%, the second company is making twice as much money per dollar spent on goods. Assuming other costs are roughly equal between the two companies, the second company is probably the better investment opportunity.
- It's best to compare companies in the same sector. Some goods and services have a lower average profit margin than others.
