What Does a Low Gross Profit Percentage Mean?
Every for-profit business aims to make more money that it spends over the long-term. When a business does not take in more money than it spends, it loses money over time, which can lead to high levels of debt and business failure. Gross profit percentage or gross profit margin is a measure of a business' profitability that can provide insight into the health of the business.
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Definition
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Gross profit percentage is the proportion of total sales a company has left over after subtracting the cost of goods sold. The cost of goods sold is expenses that can be directly attributed to producing specific products. For instance, if a company makes fire hydrants, the cost of the pipe, nozzle and other physical parts and materials that go into production and the cost of labor necessary to assemble the end product make up the cost of goods sold. Costs such as taxes, interest on debt, rent and other overhead costs are not included in the cost of goods sold.
Low Markups
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If a company has a low gross profit percentage, it is charging prices on products that are close to the actual costs of producing those products. For example, if a company's cost of goods sold is $45,000 and its total sales are $50,000, its gross profit percentage is equal to the $50,000 minus $45,000 divided by $50,000, which is 10 percent. The company's markup -- the percentage by which the price of products exceed the costs of production -- is $5,000 divided by $45,000 or 11 percent. This means the company is only charging 11 percent more for its goods than the cost of producing those goods.
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Losing Money
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Since gross profit percentage does not include costs like taxes, interest on debt, and rent, a company with a low gross profit percentage may be losing money after such costs are taken into account. For example, if the company with a cost of goods sold of $45,000 and $50,000 of revenue also had $10,000 in costs that are not included in the cost of goods sold, it would have lost $5,000.
Considerations
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Net profit margin is a measure that is similar to gross profit percentage, except that it takes all costs into account. Using the same example, a company with $50,000 in revenue and $55,000 in total costs would have a net profit margin of $50,000 minus $55,000 divided by $50,000, which is -10 percent.
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