The Gross Profit Margin Ratio is one of the profitability ratios which shows how efficiently the company has generated revenues from the sale of its goods and inventories. It measures the amount of profit generated after deducting the direct expenses related to the production of goods and services.
So, what about the meaning of gross profit? Gross profit is basically the difference between the revenues generated and the cost of goods sold. This gross profit margin ratio shows the margin left after deducting the manufacturing cost. The manufacturing cost includes the material cost, staff and manufacturing cost.
Since gross profit margin ratio measures the efficiency of production and pricing, therefore it is very useful for comparing the current gross margins with that of the previous years. Formula to calculate Gross Profit Margin Ratio is:
Gross Profit Margin Ratio = Gross Profit/Net Sales
Where, Gross Profit = Revenues – Cost of goods sold
Higher ratio value shows that the company is selling its inventory and the goods at a high-profit percentage. The higher ratios are more favorable.
Company A has a net sales of $10,000 and its Cost of Goods Sold is $6,000. Then the Gross profit will be 4,000 (i.e. 10,000-6,000) and the this ratio will be:
= 4,000/10,000 = 0.4 or 40%
To find out about other profit margin ratios:
And also other profitability ratios.