One of the many profitability measures for companies you might invest in is the gross profit margin. Knowing what can cause a company's gross profit margin to change, as well as factors not affecting the gross profit margin, helps you interpret the significance of the change for the company's financial future.
Change in Costs of Goods
If the cost the company pays for the goods it sells changes, its gross profit margin will also change. For example, as a company expands, it may be able to take advantage of volume discounts and pay a lower price for the goods it sells, which would result in a higher gross profit margin. However, if a shortage of raw materials causes the price to increase, the gross profit margin will decrease.
Change in Selling Price
A change in the selling price of goods also causes the gross profit margin to change because it alters revenue. For example, if the company decides to raise its prices, the revenues generated per good sold would go up, which would raise the gross profit margin. However, if prices fell -- for instance, if the company had to lower costs to compete with new competitors in a given market -- the gross profit margin would also fall.
Gross Profit Margin Formula
The gross profit margin formula uses the gross profit, as calculated by subtracting the total cost of goods sold from the total revenue, divided by the total revenue. For example, if the company has $8.6 million in revenues and $5.2 million in costs of goods sold, subtract $5.2 million from $8.6 million to get a gross profit of $3.4 million. Then, divide the gross profit of $3.4 million by $8.6 million to find the gross profit equals 0.3953, or 39.53 percent.
The gross profit margin only takes into account two variables: the cost of goods sold and the revenues generated. Therefore, it does not account for a number of the costs a company incurs in the normal course of business. For example, an increase in rent charged by the landlords of the company's stores would not affect the gross profit margin. Similarly, an increase or decrease in the corporate tax rate may change the company's after-tax profits, but it will not affect the gross profit margin.