Gross profit margin is one of the profitability ratios used to gauge the general profitability of a firm. This ratio represents the relationship between gross profit and net sale of a firm. The main usability of this ratio is to measure the effectiveness of firm to generate profit out of its sale.
Gross profit margin is also known as ‘Gross margin’.
Formula for calculation of gross profit margin:
Gross margin is calculated by dividing the amount of gross profit by net revenue (net sale).
Gross profit ratio = Gross profit/ Net sale
Gross profit is calculated by deducting the amount of cost of goods sold from net sales. Therefore, below formula can also be used in calculation of gross profit ratio
Gross profit ratio = (Sales – COGS)/ Net sales
Cost of goods sold (COGS) = Opening stock + Purchases – Closing stock
The higher degree of this ratio shows that management is effectively generating profit while incurring lower cost of goods sold.