What is the Gross Profit Ratio?
The term “gross profit ratio” refers to the profitability measure that is computed by deducting the costs of production that can be directly allocated to the manufacturing unit, such as the cost of raw material, direct labor cost, etc. In other words, it helps in computing how much of every dollar of revenue is left post deduction of all the direct cost of production (also known as the cost of sales or cost of goods sold).
Theoretically, the higher the GPR, better it is for the company as the excess money can be used to pay off other operating expenses, such as selling expenses, general & administrative expenses, marketing expense, interest expense, etc. On the other hand, a low or negative GPR is a warning signal as it indicates a weak operating performance of a company.
Formula
The formula for GPR can be derived by deducting the cost of goods sold from the total revenue and then dividing the result by the total revenue. The ratio is usually expressed in terms of percentage. Mathematically, it is represented as,
The total revenue is the product of the average selling price per unit and the number of units sold, while the cost of goods sold primarily consists of the cost of raw material and direct labor cost. Both of them are important financial metrics and as such, they are easily available in the income statement of any company.
Total Revenue = Average Selling Price Per Unit * Number of Units Sold
Cost of Goods Sold = Cost of Raw Material + Direct Labor Cost
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Examples of Gross Profit Ratio (With Excel Template)
Let’s take an example to understand the calculation of the Gross Profit Ratio formula in a better manner.
Example – #1
Let us take the example of GHJ Ltd in order to demonstrate how to calculate the GPR of a company. GHJ Ltd is a toy manufacturing company and according to its latest income statement, the company sold 30,000,000 different types of toys during the year at an average selling price of $5. Also, the cost of raw material and direct labor cost of production during the year stood at $55 million and $30 million respectively. Calculate the gross profit ratio of GHJ Ltd during the year based on the given information.
Solution:
Total Revenue is calculated by using the formula given below
Total Revenue = Average Selling Price Per Unit * Number of Units Sold
- Total Revenue = $5 * 30,000,000
- Total Revenue = $150,000,000
Cost of Goods Sold is calculated by using the formula given below
Cost of Goods Sold = Cost of Raw Material + Direct Labor Cost
- Cost of Goods Sold = $55,000,000 + $30,000,000
- Cost of Goods Sold = $85,000,000
It can be calculated by using the formula given below
Gross Profit Ratio = (Total Revenue – Cost of Goods Sold) / Total Revenue * 100
- GPR = ($150,000,000 – $85,000,000) / $150,000,000 * 100
- GPR = 43.33%
Therefore, GHJ Ltd managed a gross profit ratio of 43.33% during the year.
Example – #2
Let us now take the annual report of Apple Inc. for the year 2018. According to the latest annual report, the company registered net sales of $265,595 million, while the cost of sales for the year stood at $163,756 million. Calculate the gross profit ratio for Apple Inc. for the year 2018.
Solution:
It can be calculated by using the formula given below
Gross Profit Ratio = (Total Revenue – Cost of Goods Sold) / Total Revenue * 100
- GPR = ($265,595 million – $163,756 million) / $265,595 million * 100
- GPR = 38.34%
Therefore, Apple Inc. registered a gross profit ratio of 38.34% during the year 2018.
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Example – #3
Let us now take the annual report of Walmart Inc. for the year 2018. As per the latest annual income statement, the net sales and cost of sales of the company stood at $495,761 million and $373,396 million respectively. Calculate the gross profit ratio for Walmart Inc. for the year 2018.
Solution:
Gross Profit Ratio is calculated by using the formula given below
Gross Profit Ratio = (Total Revenue – Cost of Goods Sold) / Total Revenue * 100
- GPR = ($495,761 million – $373,396 million) / $495,761 million * 100
- GPR = 24.68%
Therefore, Walmart Inc. managed a gross profit ratio of 24.68% during the year 2018.
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Advantages and Disadvantages of GPR
Below are some of the advantages and disadvantages of gross profit ratio are as follows:-
Advantages
- The ratio gives a fair idea about the operating efficiency of a company.
- This ratio can be used to monitor the operating performance of a company over a certain period of time vis-à-vis its peers.
Disadvantages
- It does not include all the expenses, such as interest expense, selling expenses, etc. As such, the ratio fails to present the true state of its overall profitability.
- Very difficult to benchmark what is an acceptable level GPR.
Conclusion
So, the gross profit ratio can be a useful profitability metric. But it cannot be used as a standalone ratio and should be complemented by other performance metrics to draw meaningful insights.
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