Gross Profit Margin

How is it calculated?

Gross Profit Margin = (Revenue - Cost of Goods Sold) / Revenue

Goal of the Ratio

The goal of this calculation is to show the amount of profit generated from a sale as a percentage of the overall sales price.  Let’s look at it from the perspective of a coffee roasting business.  If the business sells a bag of coffee for $10, that would be the revenue.  To determine the Gross Profit, you would then deduct the direct costs of the item being sold (in this case it would be the coffee, the bag and the label).  If those items cost $6, then the gross profit would be $4 ($10 - 6 = $4).  To show this is a Gross Profit Margin, you would divide the Gross Profit by the Revenue, and in this case that would be 40% ($4 / $10 = 40%).  

Please note this only deducts the “direct costs” and not indirect costs of the business (rent, receptionist wages, etc).    

When is it used?

All business situations

Rules of Thumb

Higher is better - Please note all ratios should be viewed in relation to industry norms to determine overall adequacy.

What changes in the ratio could mean:

Some example reasons why Gross Profit Margin can change:

1. Changes in Sale Price

2. Changes in Cost of Goods Sold

Other Relevant Terms

• Capacity
• Income Statement
• Revenue
• Cost of Goods Sold
• Gross Profit
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