Gross Profit Margin Ratio: Calculation & Definition

Execs may rationalize that selling drives business activity and growth. Alternatively, they may have failed to institute safeguards for protecting margin before asking their teams to generate more sales. In either scenario, generating sales without regard for cost can lead to a declining gross margin and serious business problems.

Gross profit is defined as the difference between the net sales and the cost of goods sold (i.e., the direct cost of sales). The value of net sales is calculated as the sales minus returns inwards. Does your business regularly buy and use the same supplies over and over? These could be for daily operations, to make goods, or even to ship products to customers. Whatever your regular supplies are, don’t just buy them when you need them. Pay attention to the price, and buy in bulk when prices are low or supplies are on sale.

To find a company’s net margin, tally the cost of goods sold along with indirect operating expenses, interest expenses, and tax expenses. Combine all of these line items into a single metric called total expenses. Gross Margin Ratio, also known as Gross Profit Margin, is a financial metric that measures a company’s profitability by comparing its gross profit to its net sales. It is expressed as a percentage and helps businesses understand how much money is left after covering the cost of goods sold (COGS). As an example of how to calculate gross margin, consider a company that during the most recent quarter generated $150 million in sales and had direct selling costs of $100 million.

How to calculate profit margin

A couple of reasons for this steadiness may be the company’s position as a premium provider of coffee and the nurturing and control of its supply chain. Gross margin is a financial metric that provides essential insights into a company’s production efficiency and overall profitability. To define gross margin in simpler terms, it is simply gross profit, stated as a percentage of the revenue. This might entail renegotiating supplier contracts, adopting more efficient production techniques, or leveraging technology to reduce waste.

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  • By exclusively considering costs directly tied to production, it offers a clear picture of a company’s ability to generate profit from its core operations.
  • This is the most complicated ratio formula, so you may need to use accounting software for the calculation.
  • Determining individual financial ratios per period and tracking the change in their values over time is done to spot trends that may be developing in a company.
  • Gross Margin Ratio, also known as Gross Profit Margin, is a financial metric that measures a company’s profitability by comparing its gross profit to its net sales.
  • All the terms (margin, profit margin, gross margin, gross profit margin) are a bit blurry, and everyone uses them in slightly different contexts.
  • A company may have high operational or marketing expenses that can offset the benefits of a robust gross margin.

There is no definite answer to “what is a good margin” — the answer you will get will vary depending on whom you ask, and your type of business. Firstly, you should never have a negative gross or net profit margin; otherwise, you are losing money. However, it’s crucial to remember that a robust gross margin doesn’t guarantee overall net profitability, as other expenses can offset it. Past performance, while not an infallible predictor, offers invaluable insights.

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It’s therefore important to compare profitability with similar companies when using this calculation. The cost of goods sold is the direct labor and material costs for creating products. It takes effort, but you should review your profitability ratios each month and make changes to improve outcomes. Let’s say that two restaurants have each raised $1 million by issuing stock to investors. So restaurant A is earning a higher return on the $1 million in equity.

This comparison allows businesses to benchmark their performance, identifying if they are leaders, laggards, or somewhere in between. A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation. Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications. Our work has been directly cited by organizations including Entrepreneur, Business Insider, Investopedia, Forbes, CNBC, and many others. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice.

Margin Calculator

You can find the revenue and COGS numbers in a company’s financial statements. Amanda Bellucco-Chatham is an editor, writer, and fact-checker with years of experience researching personal finance topics. Specialties include general financial planning, career development, lending, retirement, tax preparation, and credit. There is a wide variety of profitability metrics that analysts and investors use to evaluate companies. Marking up goods (selling goods at a higher price) would result in a higher ratio.


Gross profit margin is your profit divided by revenue (the raw amount of money made). Net profit margin is profit minus the price of all other expenses (rent, wages, taxes, etc.) divided by revenue. While gross profit margin is a useful measure, investors are more likely to look at your net profit margin, as it shows whether operating costs are being covered. So the difference is completely irrelevant for the purpose of our calculations — it doesn’t matter in this case if costs include marketing or transport.

What Does Gross Margin Tell You?

There is one downfall with this strategy as it may backfire if customers become deterred by the higher price tag, in which case, XYZ loses both gross margin and market share. A company’s management can use its net profit margin to find inefficiencies and see whether its current business model is working. If you find yourself struggling to calculate gross margin, you may find it easier to use some of the best accounting software currently available instead. By boosting sales, even if COGS remains constant, the gross margin can see a positive uptick.

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The gross profit margin can be used by management on a per-unit or per-product basis to identify successful vs. unsuccessful product lines. The operating profit margin is useful to identify the percentage of funds left over to pay the Internal Revenue Service and the company’s debt and equity holders. Gross profit margin indicates a company’s sales performance based on the efficiency of its production process or service delivery. It’s calculated by subtracting direct costs from revenue, dividing that figure by revenue and then multiplying by 100. The gross profitability ratio is an important metric because often, the cost of goods sold balance is a company’s largest expense.

This is a very important aspect of using ratios as a tool of evaluation. A ratio in itself is not particularly useful unless it is compared with similar ratios obtained from a related source. When you think of free cash flow, consider the cash inflows you don’t have to use for a particular purpose. You have the flexibility to use the cash for any purpose, which is why free cash flow is so valuable.

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