Equation for Gross Profit Percentage

Gross profit is found on the income statement.

Investment analysts commonly look at gross profit as a way to measure a company's business models. Unlike some other financial ratios, gross profit can be compared across industries. In general, the higher the gross profit compared to other businesses, the better the business model. Gross profit is calculated by subtracting the cost of goods sold from sales. Gross profit percentage is calculated by dividing gross profit by sales and then multiplying by 100.

Annual Report

The annual report is a full disclosure document produced by the management of a company in order to explain the financial condition of a company. It contains the income statement, the balance sheet, and the cash flow statement. While all three of these are used by investment analysts to evaluate a company, the income statement is the one used to assess the company's business model and earnings.

Income Statement

The income statement is a summary of company earnings. It always starts out with either company revenues or company sales. The next line item is the cost of goods sold, which is the cost of inventory or assets sold during production and is directly related to the generation of sales. The cost of goods sold, also referred to as COGS, includes the direct labor associated with creating the good.

Gross Profit Percentage

Gross profit is calculated by subtracting the cost of goods sold from total sales. This provides analysts with a clear understanding for how much the company's sales cost without any consideration for operational expenses such as rents or salaries. In order to compare the calculation against other companies in the same industry as well as other industries, analysts divide gross profit by total sales or revenue and then multiply by 100 for a percentage. The higher the gross profit percentage, the better the company is at managing assets.

Summary

During the start of the dot.com boom, many Internet companies did not post a net income and so analysts had to determine another calculation to measure company performance. One measure they used was gross profit percentage as it does not include any other cost related to making a profit, like marketing, which was quite significant. Gross profit percentage, unlike other profitability ratios such as net income margin or operating margin, is the best measure of the business idea as it only looks at sales and the cost of generating those sales.

References

• ValueBasedManagement: Gross Profit Percentage