Gross Profit Margin Definition
Gross profit margin is the profitability ratio which is used to measure the percentage of the sales which exceed the cost of goods. GPM ratio is used to calculate how efficiently a company used its material and its labour to produce and sell its product.
This ratio shows the efficiency of the company to produce and sales its product. From this ratio, investors can know about the company that the company is healthy or not.
If the net income of the company is not healthy then the gross profit margin of that company will be negative. That company has a loss on every product but the company stay afloat because of the one-time insurance payout.
Gross profit margin formula can be calculated by subtracting the total cost of goods sold from the total asset of the company that is
Gross profit = total sales – Cost of goods sold
For the calculation of gross profit, we can get the values for the income statement. The result of this ratio in the form of dollars and also in the form of percentage gross profit margin.
For the calculation of gross profit percentage formula, we need to subtract the cost of goods sold from total sales and then divide the result of this by the total sales that are:
Gross profit = (Total sales – Cost of goods sales)/Total sales
There is the clothing business of jasmine which designs the cloth for children. Because of the performance of this business, it is branded now. Now we calculate the gross profit margin in the dollar amount of GP by putting the below amount from her business income statement into this ratio formula.
- Total sales = 1,000,000 Dollars
- COGS = 350,000 Dollars
- Rent = 100,000 Dollars
- Utilities =1,000 Dollars
- Office Expenses = 2,500 Dollars
Gross Profit Margin = Total Sales – COGS
= 1,000,000 – 350,000
GP Margin = 6,50,000 Dollars
From the above result it is clear that Jasmine has 6,50,000 dollars gross margin which means that producing cost of the product is 3,50,000 dollars which have sls price f 1M dollars. Now we find the GP margin percentage by dividing the result of GP margin by total sales.
GP Margin Percentage = 6,50,000/1,000,000
So jasmine get 65% GP margin percentage from his business
Management and analyst use this ratio to find how the company is efficient to produce and sell the products. In simple words, this ratio shows the profitability of the products.
For the cost accounting and for management GP margin is important because from this calculation they can make budgets and create forecast future activities. If we take the above example of jasmine’s business which has GP margin of 650,000 dollars she can invest this margin amount in new business or for the expansion of the current business.
For the comparison of the margin between companies investors typically use GP percentage margin. From this investors knows about the core business activity of the company and the profitability of the company.
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