What is Gross Profit Margin Ratio?
Gross Profit Margin is important metric used to measure profitability and the efficiency of the management regarding direct cost and sales.
It reveals the amount of revenue is left over after paying direct product costs are called as cost of goods sold(COGS). A negative gross profit margin reflects the company is making miss out on production.
Gross Profit Margin Ratio Formula
The gross profit margin percentage formula is calculated by dividing gross profit by net sales.
Gross profit percentage= (Gross profit/Net sales)
Gross profit or gross margin is the net sales minus cost of goods sold.
Gross profit = Net sales- COGS
Net sales or revenues includes sales and others income such as interest, dividends, rents etc .
COGS refers to direct cost associated with manufacturing the products have been paid. It includes direct materials, direct labors etc
Gross Profit Margin Ratio Example
It is shoe manufacturing company. The name of the company is ABC Ltd. Here is some information about the ABC ltd.
Income statement for the year ended on 31.03. 2019
Now, Gross profit= 20,00,000 - 10,00,000
= 10,00,000
Therefore, Gross Profit Percentage= (10,00,000/20,00,000) = 0.5 or 50%
It means ABC LTD has 50% of its revenues left over after paying the direct cost. This is cost of goods sold.
Gross Profit Margin Ratio Analysis
Gross profit margin is an important method because it views company management and investors how efficiently the business is at producing and selling products. In other words, it shows how profitable it is.
The gross profit is very meaningful concept cost accounts and company management when they are creating budgets and forecasting the future activities.
Suppose, gross profit of ABC LTD is Rs 300,000, that means if the company ABC wants to profitable for coming year, all the cost must be less than Rs 300,000. On the other hand, ABC ltd could also view the Rs 300,000 as the amount of money that can be invested in future growth.
A higher gross profit ratio shows the efficiency of the management to earn profit before meeting indirect expenses. A higher gross profit ratio is a very favorable situation earn net profit.
A lower gross profit ratio reveals the inefficiency management and low level of profit. It effects on net profit after meeting all indirect expenses.
What is a good gross profit margin ratio?
As a rule of thumb, gross profit margin should be between 20% to 30% and its vary widely by sector and company size.
The gross profit margin is to be more useful when find out a trend of past few years and compare companies within same sector to judge efficiency of the management and company and to identify weak areas of management and company.
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