How to Calculate Gross Profit Percentage (With Tips)
Updated July 9, 2022
The gross profit percentage is an important measure of profitability for a business. It quantifies a company's efficiency in utilizing its production input expenses, such as raw materials and labour, to successfully create and sell its goods. Learning how to calculate gross profit percentage can help provide you with insight to increase a company's operational efficiency. In this article, we define gross profit percentage, describe how to calculate it, discuss its importance, highlight tips for evaluating the percentage, discuss how to increase it, and define gross profit ratio.
What is gross profit percentage?
Gross profit percentage is a measure of profitability that assesses how much revenue remains after paying off the cost of goods sold (COGS). It estimates the efficiency of a corporation in maximizing its input costs of production, such as raw materials and labour to manufacture and sell its goods profitably. These resources are used to calculate COGS, which businesses rely on for operations management. The gross profit percentage represents the rate at which businesses benefit from COGS.
COGS may include costs associated with the production and sale of products and services, such as raw materials, labour, and inventory storage fees. Businesses calculate the gross profit percentage by subtracting the cost of goods sold from the net sales for a specified period. The outcome is gross profit, which is calculated by dividing total sales income from the same period by the rate at which a business's sales surpass its direct manufacturing expenditures. Calculating gross profit percent requires the application of a formula that yields the gross profit margin in percentage form:
Gross profit percent = (gross profit ÷ net sales revenue) x 100
How to calculate gross profit percentage
Calculate the gross profit margin using the procedures below and the formula above:
Calculate the total amount in sales. Calculate the period's net sales revenue. You may calculate net sales as the money earned by all sales during the period, minus returns, discounts, and any allowances provided by businesses for items and services.
Calculate the gross profit. You can calculate the gross profit by subtracting the COGS from the net sales revenue generated by a business over a certain time.
Divide the gross profit and the net sales revenue and then multiply it by 100. Divide the gross profit and net sales revenue by 100. This provides the gross profit percentage, which may be used to calculate profitability.
Calculate the percentage profit. Calculating the percentage helps to determine what the rate indicates for your team or the organization.
Related: What Is Quantitative Analysis?
Gross profit percentage example
Here is an example of gross profit percentage calculation:
"Lakeshore Retailers is a Vancouver-based retail firm that sells clothing and other apparel. The organization wishes to compute its gross profit percentage. They calculate that their net sales revenue for this time period is $205,000 after subtracting refunds and discounts from their gross sales. They then determine that their gross profit is $119,000 after subtracting the cost of goods sold from the net profit of the business. Using the formula, the CFO calculates the company's gross profit percentage of Lakeshore Retailers:
Net Sales: $205,000
Gross Profit: $119,000
Formula: 58% = (119,000 ÷ 205,000) x 100
The company's gross profit percentage is 58%."
A gross profit margin of 58% shows that the organization is efficiently using budget resources to generate sales. A decreased profit margin indicates inefficiency in one or more parts of the manufacturing and sales operations.
Importance of calculating gross profit percentage
The gross profit rate is an important indicator because it indicates how profitably businesses may invest in operations. Several more reasons for calculating this measure include the following:
Understand the business's profitability
One of the most critical reasons to examine the gross profit percentage is to have a better understanding of how a business can generate revenue from the expenses of products and services produced. If a business's profit percentage is lower than expected, this may suggest a difficulty in reaching sales targets. When investors and shareholders evaluate a company's efficiency and financial health, they regularly consider profit ratios.
Evaluate the efficiency of operations
Businesses can also compute the gross profit rate to see how effectively their production teams support sales targets. For example, a manufacturing organization may examine the gross profit margin to ascertain how well teams accomplish production targets so that they can begin to prepare items for sale. If inventory levels get depleted as a result of teams failing to fulfil production targets, this can influence sales income, resulting in swings in the gross profit rate. Assessing this measure can be beneficial in determining the efficiency of the manufacturing process used to create and sell items.
Evaluate methods of improvement
Another reason that measuring the gross profit margin is critical is that it allows you to see which sales and manufacturing processes can improve. For example, if the gross profit margin indicates that expenses exceed revenues, manufacturing organizations may develop measures to enhance production processes. Retailers may also use profit margins to evaluate which sales procedures are to be improved to foster more productive client relationships that result in increased sales.
Provides management with a precise estimate of the amount of money available for reinvestment
Assessing how much money remains after you deduct all expenditures is critical because it reveals to management how much revenue they can reinvest in the business. A high gross profit margin enables those responsible for the organization's growth to dedicate resources toward brand recognition, recruiting new employees, and other strategies to improve the business. This can also make the company attractive to new investors.
Plan sales and pricing strategies
Sales teams can also benefit from calculating the gross profit margin, as it can indicate where the majority of sales occur. For instance, a retailer selling textiles may calculate the gross profit rate to identify which goods sell the most frequently. Products that sell less often can still generate revenue, and sales teams can use this information to develop new pricing models and advertising strategies.
Tips for evaluating gross profit percentage
When examining the gross profit margin, consider the following tips in mind:
Utilize the gross profit margin with other financial measures. This enables you to more accurately assess profitability and the financial health of a business.
Evaluate price strategies for products. Understanding the effect of changing product prices on gross profit margins may assist sales teams in optimizing their present pricing strategies.
Keep in mind that profit margins fluctuate. While changes in corporate structure, operating procedures, or sales tactics may influence gross profit margins, it's critical to be aware of constant changes, as they may suggest inefficiency in one or more areas of production and sales.
How to increase gross profit percentage
If you're a member of a team tasked with increasing a company's gross profit margins, you can implement the following strategies:
Reduce the price of items. Generally, purchasing in bulk can entitle you to a discount. Additionally, you may purchase things at a seasonal discount and store them until you may need them.
Automate your business processes. Investing in software or programs that automate some activities can help you save money, enhance efficiency, and increase accuracy.
Negotiate prices with subcontractors. Generally, you may secure cheaper rates if you pay your subcontractors before the start of work and enroll in automated payments.
Utilize a variety of pricing tactics. Pricing methods frequently dictate gross margins, and businesses typically price their products in response to their competitors' pricing. You may alternatively pursue a margin-based pricing strategy, in which you price higher than the market to optimize the gross margin, but this plan may require a substantial marketing effort to generate sales.
What is gross profit ratio?
Gross profit margin (GP margin) is a financial ratio that indicates a business's profitability and efficiency by dividing gross profit by total net sales. Gross profit margins can also be in percentage terms by multiplying them by 100. You can then refer to this value as gross profit percentage or gross profit margin.
Calculating a business's gross profit involves calculating total sales over a certain time period and subtracting the total costs of labour and materials required to manufacture the goods and services sold by the organization. The net sales number for a business comprises all of its gross sales during a certain time period, and revenue from other sources such as interest, rental properties, royalties, and others, minus its returns, allowances, and discounts.
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