Gross Profit Margin is a metric that analysts use to assess a company’s financial health by calculating the amount of money left over from product sales after reducing the cost of goods sold (COGS) .
Sometimes gross profit margin is referred to as gross margin ratio, gross profit margin is often expressed as a percentage of sales.
Key Explanation
- Gross Proft Margin (GPN) is an analytical metric expressed as a company’s net sales less cost of goods sold (COGS).
- Gross Proft Margin (GPN) is often shown as gross profit as a percentage of net sales.
- Gross Proft Margin (GPN) shows the amount of profit made before deducting sales, general and administrative expenses, which is the company’s net profit margin.
Formula for Gross Profit Margin (GPM)
GPM = GP / Sales Revenue
Remarks:
- GP = Gross Profit
- GPM = Gross Profit Margin
How to Calculate Gross Profit Margin (GPM)
The percentage of a company’s gross profit margin or gross profit margin (MLK) is calculated by dividing gross profit by sales revenue. The figure for the distribution in the form of a presentation is called the gross profit margin.
Problems example:
Company A’s gross profit is USD 200,000 and the sales revenue it receives is USD 350,000. So to get the results of the Gross Profit Margin, the calculation is as follows.
- Gross profit margin = USD 200,000 / USD 350,000.
- Gross profit margin = 57%.
What can Gross Profit Margin tell you?
If a company’s gross profit margin fluctuates wildly, this may signal poor management practices and / or lower product prices.
On the other hand, such fluctuations can be justified in cases where a company makes massive operational changes to its business model, where cases of temporary volatility should be no cause for alarm.
For example, if a company decides to automate certain supply chain functions, the initial investment may be high, but the cost of goods eventually decreases due to the lower labor costs resulting from the introduction of automation.
Product price adjustments can also affect gross margins. If a company sells its products at a premium, all other things being equal, it has a higher gross margin.
But this can be a tricky balancing act because if the company charges too high, fewer customers buy the product, and the company can suffer losses as a result.
Examples of Using Gross Profit Margin
Analysts use gross profit margins to compare a company’s business model with its competitors. For example, let’s assume that Company ABC and Company XYZ both produce electronic products with identical characteristics and similar levels of quality.
If ABC Company finds a way to manufacture its product at a cost of 1/5, it will provide a higher gross margin due to a reduced cost of goods sold, giving ABC a competitive advantage in the market.
But then, in an attempt to make up for the loss in gross margins, XYZ fought back by doubling the price of its product, as a method of increasing revenue.
Unfortunately, this strategy can backfire if customers are deterred by a higher price tag, in which case, XYZ loses gross margins and market share.