How to Calculate the Gross Profit Ratio

In investing, the gross profit ratio measures the difference between how much it costs to produce a product and how much the business is selling it for. In other words, the ratio shows how much of every dollar a company earns in sales is left over after paying for the goods that were sold. Here's how to calculate it.

Things You'll Need

• Company annual report
• Calculator

Instructions

1. Calculating the gross profit ratio is a simple equation:Gross profit divided by total revenue.You can find this information in a company's annual report.

2. For this example, we'll use Microsoft's 2007 annual report. To calculate gross profit, we'll take Microsoft's revenue ($51.1 billion) and subtract its cost of revenue, also known as cost of goods sold ($10.7 billion). This leaves us with a gross profit of $40.4 billion.

3. So Microsoft's 2007 gross profit ratio looks like this:$40.4 billion (gross profit) / $51.1 billion (total revenue)= 0.79. Move the decimal point two places to the right, and you get a gross profit ratio of 79 percent. This means that after Microsoft has paid for the goods it sells, it has 79 percent of its revenue left over. This ratio may seem high, but as a software company, Microsoft's cost of goods sold is relatively low; it doesn't pay much for the physical goods it uses in its products. A furniture company, for example, would have much higher expenses for goods and thus a lower expense ratio. Make sure you do research on the average expense ratio for the industry in which the company operates to know whether a ratio is high or low in context.

Resources

• EDGAR, the Securities and Exchange Commission's database of company filings