Definition
The financial ratio known as gross profit margin is a measure of a company's ability to profitably make a product or supply a service. The metric does this by comparing the impact the cost of goods sold has on revenues.
Calculation
Gross Profit Margin = Gross Profits / Revenues
Where:
Gross Profits = Revenues - Cost of Goods Sold
The gross profit margin can also be expressed in terms of a percentage as shown below: Gross Profit Margin (%) = (Gross Profits / Revenues) x 100
Explanation
When evaluating companies, analysts and investors look for a relatively high gross profit margin. High margins indicate the company may have an advantage such as the ability to demand premium pricing, a patent, or a trade secret that allows for low manufacturing costs. The above formula demonstrates that as the cost of goods sold approaches zero, the gross profit margin approaches 100%.
When drawing conclusions about the relative performance of a company, benchmark comparisons should be made with competitors in the same industry.
Example
Company A's balance sheet indicates revenues of $29,611,000 and a cost of revenue (another name for cost of goods sold) of $15,693,000. Company A's gross profit margin would be:
= (($29,611,000 - $15,693,000) / $29,611,000) x 100 = ($13,918,000/ $29,611,000) x 100, or 47.0%
Related Terms
The income statement is a financial accounting report that demonstrates how net income, or profit, is derived from revenues. The main categories appearing on an income statement include revenues, cost of goods sold, operating expenses, non-recurring items and net income.
Moneyzine EditorJanuary 22nd, 2024- The financial accounting term revenue is used to describe the price charged to customers for good sold, or services rendered. Revenues are reported on a company's income statement.Moneyzine EditorSeptember 21st, 2023
The direct expense a company incurs when making a product, or supplying a service, such as raw materials and labor are referred to as the cost of goods sold (COGS). Also referred to as the cost of sales, the cost of goods sold appears as a line item expense on the income statement.Moneyzine EditorJanuary 12th, 2024
