Gross Profit Margin Formula (Table of Contents)
- Gross Profit Margin Formula
- Gross Profit Margin Calculator
- Gross Profit Margin Formula in Excel (With Excel Template)
Gross Profit Margin Formula
The gross profit formula is calculated by subtracting the total cost of goods sold from the total sales of the company.
Both the total sales and cost of goods sold can be found on the profit & loss statement. Occasionally, the cost of goods sold can be broken down into smaller categories of costs like raw materials and labor costs.
Gross profit margin also shows value addition done by the company on the raw material. More gross profit margins mean a company can sale its value addition at a higher price than its peer. More gross profit margins also tell about the competitive advantage company is having, as more gross profit margins mean a company has pricing power.
Above mentioned equation looks at the absolute dollar amount of gross profit for the company, but many times it is helpful to calculate the gross profit margin or rate as a percentage.
The Gross Profit Margin formula is calculated by subtracting the cost of goods sold from net sales and dividing the difference by net sales. Generally, a gross profit margins calculator would rephrase this equation and simply divide the total gross profit dollar amount we mentioned above by the net sales.
Given below is the example mentioned:
Mrs. ABC owns a furniture business that designs and manufactures high-end furniture for offices and residential. She has several different types of furniture and has proven to be one of the most successful brands in her space.
Below is what appears on Mrs. ABC’s profit and loss statement at the end of the financial year.
- Net sales: $ 1,00,000
- Cost of Goods Sold (COGS): $ 35,000
- Rent: $ 10,000
- Utilities: $ 1,000
- Office expenses: $ 2,50
Mrs. ABC wants to know her gross profit & gross profit margins.
First, we should calculate Mrs. ABC’s overall dollar amount of gross profit by subtracting the $ 35,000 of Cost of Goods Sold (COGS) from the $ 1,00,000 of total sales like this:
- Gross Profit = Net Sales – Cost of Goods Sold
- Gross Profit = $ 1,00,000 – $ 35,000
- Gross Profit = $ 65,000
As you can see, Mrs. ABC has a GP of $65,000. This means the goods that she sold for only cost her $ 35,000 to produce. Now she has $65,000 that can be used to pay for other indirect bills like utilities and rent.
Gross Profit Margin can be calculated by using Gross Profit Margin Formula as follows –
- Gross Profit Margin Formula = (Net Sales-Cost of Raw Materials ) / (Net Sales)
- Gross Profit Margin= ($ 1,00,000-$ 35,000 ) / ( $ 1,00,000)
- Gross Profit Margin = 65 %
Mrs. ABC is currently achieving a 65 percent gross profit on her furniture business. This means that for every dollar of sales Mrs. ABC generates, she earns 65 cents in gross profits before other business expenses are paid.
Significance and Use
The gross profit method is an important ratio because it shows investors and management how efficiently the business can produce and sell products. In simple words, it shows how profitable a product is when it comes to the cost of goods sold.
The concept of gross profit is particularly important to management, cost accountants, and investors because it allows them to forecast future activities and create budgets. For example, Mrs. ABC’s gross profit was $ 65,000. It means if she wants to be profitable for the whole financial year, all of her other costs must be less than $65,000. Conversely, Mrs. ABC can also view the $65,000 as the amount of money that can be put toward other business expenses or expansion into a new business or new markets.
Investors are typically interested in gross profit margins as a percentage because this shows them to compare margins between peer companies no matter their sales volume or size. For example, an investor can see Mrs. ABC’s 65 percent gross profit margin and compare it to XYZ’s gross profit margins even though XYZ is a billion-dollar firm. It also allows investors a chance to see how much profit the firm’s core business activities are.
Eicher Motors is a good example of higher gross profit margins than peers. Eicher Motors has the highest gross profit margins compared to all its peers. It shows the company has a strong core business operation and has the pricing power to pass on the increase in raw material cost to customers. It makes more sense to invest in such a company that has good gross profit margins and has pricing power over the customers. It shows how healthy business growth was and it will be.
Investors also use gross profit margins to measure the scalability of the business. Good gross profit margins business investors can run different models with their margins to compare how profitable the company would be at different levels of sales.
Gross Profit Margin Calculator
You can use the following Gross Profit Margin Calculator.
|Gross Profit Margin =||
Gross Profit Margin Formula in Excel (With Excel Template)
Here we will do the same example of the Gross Profit Margin formula in Excel. It is very easy and simple. You need to provide the two inputs of Gross Profit and Gross Profit Margin.
You can easily calculate the Gross Profit Margin formula in the template provided.
So first, we need to calculate Gross Profit.
Gross Profit = Net Sales – Cost of Goods Sold
Then we need to calculate Gross Profit Margin using Formula.
Gross Profit Margin Formula = (Net Sales – Cost of Raw Materials ) / (Net Sales)
i.e. Gross Profit Margin Formula = Gross Profit / Net Sales
This has been a guide to the Gross Profit Margin formula, here we discuss its uses along with practical examples. We also provide you with a gross profit margin calculator along with a downloadable excel template –