Gross Profit Margin

The grosser your gross profit percentage, the better

Gross profit margin is one of the best indicators of the operating efficiency of a business, and the strength of it's products in the market.

This is where businesses with tight working capital management will reap the benefits of their efforts.

The higher the gross profit percentage, the more likely that the business is in a commanding position against it's competitors, and with it's customers. This can only mean that the customers believe the products or services have real value, and this in turn translates into better sales prices.

Gross Profit Definition

Gross Profit = Sales(Turnover) - Cost of Sales

Gross profit (GP) is the number that remains when you take away from your sales figure, all the direct costs associated with making those sales.

In a manufacturing business this would be raw materials, labour, process costs, warehousing etc

In a retail business this may be the cost of goods purchased, plus the costs of buying those goods in, and again the cost of storage

Definition

Gross Profit Margin = Gross Profit / Sales

In the example above, Gross Profit is $12,400 and Sales for the period are $97,500. Applying the Gross Profit Formula, we get:

$12400 / $97500 = 12.72%

Typically, in a business with little or no branding, negligible intellectual property profit margins will be low. This is a commodity type business.

In a business with some kind of competitive advantage (even if you can't identify it) then gross profit percentages will be high. Typical examples include small town newspapers, drugs companies, some software companies.

If you compare the gross profit from period to period, you can see whether the company is making progress in the right direction

If you compare the gross profit ratio to other companies, it provides a useful comparison, but you do have to use caution as no two businesses are alike, and even similar companies will have different customers, and different product mixes

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