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# Gross Profit Margin Ratio Analysis

Modified on 2012/08/16 11:42 by swathen Categorized as Uncategorized
Financial Ratios
Operating Profit Margin Ratio
Net Profit Margin
Margin vs Markup

# Gross Profit Margin Ratio Definition¶

The gross profit margin ratio, also known as gross margin, is the ratio of gross margin expressed as a percentage of sales. Gross margin, alone, indicates how much profit a company makes after paying off its Cost of Goods sold. It is a measure of the efficiency of a company using its raw materials and labor during the production process. The value of gross profit margin varies from company and industry. The higher the profit margin, the more efficient a company is. Gross profit margin can be assigned to single products or an entire company.

## Gross Profit Margin Ratio Formula¶

Gross profit margin = Gross profit ÷ Total revenue

Or = (Revenue – cost of goods sold) ÷ Total revenue

## Gross Profit Margin Ratio Example¶

Joe is a plumber in Houston, Texas. He has recently started his company and has a lot to learn. Joe thinks he may be able to cut back on raw materials by changing his construction process. Essentially, he is wondering what is his gross profit margin rate is. He evaluates his company financials for relevant information. Once the proper numbers are found uses the gross profit margin ratio calculator on his Texas Instruments BA II. His results are shown below.

## Gross Profit Margin Ratio Calculation¶

The gross profit margin ratio would be calculated using:

Gross profit = revenue – cost of goods sold

Example: a company has \$15,000 in sales and \$10,000 in cost of goods sold.

It would be expressed as a percentage of sales by:

Gross profit margin ratio = (15,000 -10,000) / 15,000 = 33%

This means for every dollar generated in sales, the company has 33 cents left over to cover basic operating costs and profit.

## Applications of Gross Profit Margin¶

The gross profit margin ratio is an indicator of a company’s financial health. It tells investors how much gross profit every dollar of revenue a company is earning. Compared with industry average, a lower margin could indicate a company is under-pricing. A higher gross profit margin indicates that a company can make a reasonable profit on sales, as long as it keeps overhead costs in control. Investors tend to pay more for a company with higher gross profit.