## Calculating the Gross Profit Margin

There are many profitability ratios that could be used as a measure to check the profits generated by the company. These are important to calculate not only to find the profit earned by the company but are also useful to determine the other elements related to profit e.g. amount of tax etc. These profitability ratios are divided into different types and Gross Profit Margin is one such profitability ratio.

Gross Profit Margin:

One of the means to assess the financial condition of the firm is by calculating its Gross Profit Margin. It is calculated to see the number of revenues left after the utilizing of money for Cost of Goods Sold.
It can serve as a mean to predict the extra expenses that could be involved in the business as well as the savings that could be generated for the future. It is also called as gross margin.

Calculating the Gross Profit Margin:
The financial specialists have devised a simple formula with the help of which it is easy to calculate the Gross Profit Margin of the company. All you need is the information from the financial statements of the company.
The formula that could be applied to calculate the GPM is

Gross Profit Margin =(Revenues - costof goods sold ) / Revenues

The information regar(ding the cost of goods sold usually comes from the income statement of the company.

Example:
The phenomenon of calculating the Gross Profit Margin of the company can be easily understood with the help of a simple example. Lets us suppose that a random company says ABC deals in producing widgets and earned revenue of about \$ 20 million. It incurred about \$ 10 million in COGS and other related expenses. So, the ABC Gross Profit would be calculated by following method:
Gross Profit Margin = (20 million - 10 million)/20 million = \$ 0.50 or 50%.

Interpretation:
This amount of \$ 0.50 is an indication that at the end of the day each dollar earned by ABC would generate a profit of about \$ 0.50 for it. The higher the GPM of a company the better it is. You can compare this figure of your company with that of yours competitors. While interpreting the Gross Profit Margin, it is important to known the type of industry in which the company is operating as it can greatly influence the analysis and interpretation.

Importance of Calculating Gross Profit Margin:
·         As mentioned earlier, Gross Profit Margin is a key factor to analyze when analyzing the profitability and profit-generating abilities of the company. By carefully taking this measure into consideration, it becomes easier for the investors and by the analysts to decide the best and to compare all the companies in the whole industry. This is also a factor to show that whether the product or service of the company is capable of generating profit or not. So, higher the percentage of GPM, better the chances for the company to generate profits after covering its costs.
·         It can also be used as a base to determine the pricing, cost structure and production efficiency of the company.

·         It also serves as a measure to know how much a company could spend for its operating costs so that after covering these costs it could also generate profit as well. So, it means that if the GPM of the company is higher it is a clear indication that the company can generate a high level of profits even after paying all its operating costs.

·         The high Gross Profit Margin of a company also attracts greater number of investors who would willingly invest their money in your company as it could act as a guarantee that they will earn a return on their investment.

Hence the company with high Gross Profit Margins is considered to be the good profit generating companies operating in any industry and hence, could be categorized as the competition winning company.

## What Gross Profit and Gross Profit Ratio Means For Your Business

If you are running a business then it is really important for you to keep an eye on the overall performance of your business revenue. Running a business comes with a lot of advantages like being your own boss and working at your own hours but it also comes with increased responsibilities too. You end up doing more work than you did before as an employee in former company however the difference is, you love doing a lot of work for your own business.

Gross Profit
Gross profit tells you about the overall profit earned by the company. The expenses and other liabilities are not deducted from this profit. The higher the gross profit value, the better for your business. You can select a time period and calculate the gross period in that time for your business. This will give you clear idea about how close or far away you are from your targets. In general, gross profit should be large enough to cover all the operating expenses of a company which are also called overhead expenses as well.
You can calculate the gross profit of your company with the help of following formula;
Gross Profit (GP) = Net Sales – Cost of Goods Sold

Gross Profit Ratio
You would definitely be interested in knowing about the ratio of gross profit. This value will give you a clear idea about the profit that you are making on sales or as we call it the Gross Profit Ratio. In simple words, gross profit ratio is the percentage of profit made on all the sales.
Let’s assume:
Net Sales = \$100,000
Cost of Goods Sold = \$50,000
Gross Profit = \$100,000 - \$50,000 = \$50,000

Now we can calculate the Gross Profit Ratio (GPR) by dividing the Gross Profit (GP) by Net Sales and then multiplying the factor with 100.
GPR = {Gross Profit (GP) / Net Sales} x 100
(\$50,000 / \$100,000) x 100
GPR = 0.5 x 100
GPR = 50%
While you can get a good idea about business profitability with the help of Gross Profit but it is of limited significance. On the other hand, the GPR is a mathematical ratio and it contains more meaning than GP. With the help of GPR, you can compare the values with other businesses in the market and determine where you are lagging behind.
If you own a business and the GPR is 50% then you can call your local market research companies, chamber of commerce and associations related to your industry and ask them what is the GPR of other companies in the market that deal in same products and services as you do.
It can be said that GPR opens up a new window of comparison and opportunities for you. You can analyze your business from a different scale and decide how to increase the profitability in long run.

## Gross profit ratio defination

Gross profit ratio defination

Gross profit ratio is a profitability ratio that shows the gross profit as a percentage of total net sales revenue. It is a popular tool to evaluate the operational performance of the business. It is computed by dividing the gross profit figure by net sales and is expressed in percentage.

Gross profit ratio expresses relation between gross profit and net sales. It is obtained by dividing gross profit by net sales and expressing this relationship as a percentage. Gross profit is obtained by deducting cost of sold from net sales.Net sales are basically determined by deducting sales return from sales.

Gross profit ratio evaluates the effectiveness of business. It indicates the efficiency of firm in term of its production and how much it has gained a profit. Gross profit reflects the profit firm has made on cost of good sold. If firm has higher gross profit margin then it is a sign of success because all operating expenses, Interest charges and dividends would have been taken off from GP. If company increase selling price of good sold and decrease cost of good sold then this ratio increase. However if company decrease selling price of good sold and increase cost of good sold then this ratio decreased.

This ratio is also effected due to critical polices of firm. If management is not capable of improving sales volume then company will suffer from loss. Basically company analyze GP margin while considering its polices, rises and falls in purchase of products. The GP percentage indicates financial performance of firm. If this percentage is higher then its mean that firm has sufficient financial resources to pay for cost necessary to run and grow business. In this way business can be improved. On other hand if firm has lower gross profit then its mean that company has limited financial resources.

The GP percentage reflects financial data of firm. This financial data and statement is used by analysts to compare profitability between different companies. These companies which are traded publicly report sales figure to Securities and Exchange Commission (SEC). When investors compare financial performance of different companies they use sales figure and ratio analysis to assess financial condition of business. The ratio analysis basically depicts the short term financial condition of firm so more efforts could be made to improve business life in-case firm’s financial position is not satisfactory. The company can control costs of it has higher GP margin.

## Following is the Gross profit ratio formula

Gross Profit Ratio= Gross Profit/ Net Sales *100

The basic components of the formula of gross profit ratio (GP ratio) are gross profit and net sales. Gross profit is equal to net sales minus cost of goods sold. Net sales are equal to total gross sales less returns inwards and discount allowed.  The information about gross profit and net sales is normally available from income statement of the company.