Calculations for Gross Profit Margins
Gross profit margin is watched closely by investors and analysts and is a key figure that companies manage. Analyzing gross profit margin reveals a lot about a company's efficiency. Knowing how to calculate gross profit margin will help you determine how well a company is pricing its products and managing its costs.
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Calculating Gross Profit
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Gross profit equals sales minus cost of goods sold, which are found on the income statement. It is expressed as a dollar amount and shows how much money a company makes after paying the costs related to making and selling its products. Gross profit is what is left over to pay for operating expenses. A higher number is better. For example, a company with $100,000 in sales and $60,000 in cost of goods sold has a $40,000 gross profit: $100,000 minus $60,000 equals $40,000.
Calculating Gross Profit Margin
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Gross profit margin equals gross profit divided by sales. It shows what percentage of sales is available to pay for operating expenses. Like gross profit, a higher gross profit margin is better. For example, a company with $100,000 in sales and $40,000 in gross profit has a gross profit margin of 40 percent: $40,000 divided by $100,000 equals 0.4, or 40 percent.
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Interpretation
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Gross profit margin is affected by the variable costs required to make and sell products and the prices for which the products sell. A company that can control these factors can improve its gross profit margin. Gross profit margins vary widely by industry. An industry with high variable costs and competition will have lower gross profit margins than an industry with low variable costs and more pricing power. Gross profit margin is also affected by seasonal factors. For example, holiday shopping season discounts can result in lower margins.
Analysis
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Comparing a company's recent gross profit margin with historical periods identifies increasing or decreasing trends. An increasing gross profit margin could mean a company is able to charge more for its products, reduce its costs or both. A decreasing margin could mean the company is facing higher costs, price competition or both. Comparing a company's gross profit margin with competitors and the industry average reveals its competitive position among its peers.
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References
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