What Is the Gross Profit Ratio?

The gross profit ratio indicates the profitability and performance of a good. A product with a high gross profit ratio is one that earns a significant amount of profit after payment of all expenses, including overhead, cost of good sold and labor.

Computing Gross Profit

According to Berk and DeMarzo in the text "Corporate Finance," gross profit is the different between sales revenues and the costs incurred to produce the good sold. Gross profit is computed before subtracting operating expenses, interest and taxes.

Computing the Gross Profit Ratio

To find the gross profit ratio, divide the gross profit by dollar sales (revenue). Gross profit is typically expressed as a percentage; to convert this number to a percentage, multiply it by 100.

Factors Affecting the Gross Profit Ratio

Several factors may affect the gross profit ratio, including a rise in prices without a rise in associated costs, a decrease in cost of good sold without a decrease in price or an undervaluation or overvaluation of stock. The results may also be skewed if the company has a wide range of products; therefore, each unit should be calculated separately to measure its profitability.

References

• Accounting for Management: Gross Profit Ratio
• "Corporate Finance"; Berk and DeMarzo; 2007

Resources

• Encalc: Gross Profit Margin Calculator