How to calculate Gross Profit Ratio (Formula and Example)

In order to calculate gross profit ratio we require cost of good sold and the net sales of a company. In other words we require the revenue and the cost of goods sold figures of a company. Revenue of the company is also called its net sales. So the formula to calculate gross profit is as under

Net Sales= Gross Sales

Now gross profit will b calculated by deducting the cost of goods sold

Gross Profit = Gross Sales – Cost of goods sold

Again gross profit must not be messed up with the operating income. In order to calculate operating income we require net income that is the different between the gross profit and operating expenses including taxes and interest payments. 

Net Income = Gross Profit – operating expense – taxes – interest payments
Operating Profit = Gross Profit – Total operating expenses

In order to understand gross profit in a better way lets have an example of gross profit calculation. Suppose a company XYZ has revenue or net sales amount equals to $30,000. Now assume that cost of goods sold is equal to the $20,000. Now to calculate gross profit we simply need to put the formula as mentioned above:-

Net Sales/ Revenue = $30,000
Cost of goods sole = $20,000
Gross Profit= 30,000 – 20,000
Gross Profit= $10,000

Now we can simple use gross profit to calculate gross profit ratio. In order to calculate gross profit ratio we will divide the gross profit by the total revenue or the net sales and will multiply the answer with hundred.

Gross Profit Ratio= Gross Profit/ Revenue x 100
Gross Profit Ratio=10,000/30,000x100
Gross Profit Ratio= 30 percent

All the figures required to calculate gross profit and gross profit ratio are generated from the income statement of the company’s financial profile. 

Gross profit between the two companies can be calculated to measure the degree of efficiency of a company to produce same level and number of goods. For example company A and company B have sales of $ 1 million each. Assume that the cost of goods sold of company A is 90,000 dollars where as the cost of goods sold of company B is 80,000. The gross profit of company A is $100,000 where as the gross profit of company B is $200,000. This means company B uses same resources more efficiently to produce same number of products as compared to company A. in other words Company B spends less in producing the same amount of goods as produced by the company A.

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Why optimizing and Evaluating Gross Profit is important for a company

Gross profit optimization is a vital area of operation for most of the firms and companies. Gross profit is the actually what left with the firm after paying the cost of the goods sold by the company. It is one of the most important figures for a firm as it helps in determining when a firm is going to reach the break even and what will be the projected profit level beyond the break even point. In order to understand and calculate the profit margins accurately it is important to optimize the gross profit and gross profit margin. The gross profit margin shows the percent of the sales that is remained with the company after paying the direct cost associated with the goods sold. The higher the percentage and the value of the gross profit the more are the number of dollars a company retains on each good sold. For example if we have calculated the gross profit margin from the gross profit and comes to be 50 percent it means that the company will $.50 from each dollar that is generated as a revenue. 

Optimizing and evaluating the gross profit accurately will help a company in avoiding the problems associated with the low price and high production costs of the product. In contrast to this it can help to solve the problems associated with break even and the profit generated after break even. If a company attempts to increase the gross profit by lowering the price to increase the sales volume it will only worsens the conditions so it is very important to calculate the gross profit and pricing with great care.
It is important for the companies to consider the factors that will directly affect the gross profit and pay close consideration to those factors. Companies can use competitor’s data and the average of their particular industry to benchmark the level of gross profit for them. It is very important for a company to understand that factors affecting the gross profit may change during the period of time so they must keep and eye on the rise and fall of each factor.

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