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.

When it comes to business profit, there are commonly used terms; Gross Profit and Gross Profit Ratio. For a business owner, it is important to understand what these terms stand for, what they tell you about your business and how to bring those values closer to your business target/ goals. In this article, we will be discussing both the terms individually and what they tell you about your 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.

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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.
 

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Gross profit ratio formula explanation





Formula:

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.

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Example of gross profit ratio





Example:

The following data is the example of gross profit ratio for small trading company. Compute the gross profit ratio (GP ratio) of the company.
Gross sales
$
1,000,000
Sales returns

90,000
Opening stock

200,000
Purchases

590,000
Purchases returns

70,000
Closing stock

45,000

 

Solution:

With the help of above information, we can compute the gross profit ratio as follows:

= (235,000 / 910,000) × 100
=25.82%
The GP ratio is 25.82%. It means the company may reduce the selling price of its products by 25.82% without incurring any loss.
Sales

1,000,000

Less sales returns

90,000



———-

Net sales


910,000
Less cost of goods sold:



Opening inventory

200,000

Purchases
590,000


Purchases returns
70,000
520,000


———-
 ———-

Available for sale

720,000

Less closing inventory

45,000
 675,000


 ———-
———-
Gross profit


235,000



———-

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