How to Calculate Gross Margin in Analytical Procedures
Gross profit margin is an important metric for investors analyzing the financial position of companies for a number of reasons. Gross profit margin is of interest to investors both because it gives insight into the company's performance relative to its peers and because it is considered a good method to measure a company's cost controls. Calculating gross profit margin is almost always part of the basic analytical procedures that accountants and auditors perform. Gross profit margin is generally defined as gross profit divided by total sales.
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Instructions
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Determine the total sales for the period. Total sales usually includes all sales recorded during the reporting period, including installment sales. Let's say, for example, that the total sales for the quarter was $1 million.
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Calculate the gross profit by subtracting the cost of the goods from the total sales. Let's say the cost of goods was $600,000. That means you subtract $600,000 from $1 million to give you $400,000 gross profit for the quarter.
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Calculate the gross profit margin by dividing the gross profit of $400,000 by $1 million to give you a gross profit margin of .40 or 40 percent.
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Compare the current profit margin to both historical profit margins for the company and to the current profit margins of other companies in the same industry. This kind of comparison enables you to get a better understanding of the relative performance of the company and the direction the gross profit margins are trending.
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Tips & Warnings
It is important to compare profit margins over time as one-time events can skew results for a quarter or two, and always make comparisons to companies in the same industry as industry gross margins vary significantly.
