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.