As a business owner or financial analyst being able to accurately calculate gross profit percentage is an important skill. This metric shows the profitability of a company’s core business operations by looking at the revenue remaining after accounting for the direct costs of producing goods and services.
In this comprehensive guide, I’ll explain what gross profit percentage is, why it matters, and walk through the calculation steps with examples. You’ll learn how to:
- Determine the inputs needed to calculate gross profit percentage
- Use the formula to arrive at the percentage
- Analyze the results to gauge business performance
- Compare gross profit percentage to gross margin
- Use the metric to make business decisions
So if you want to master this critical financial analysis skill, read on!
What is Gross Profit Percentage?
Gross profit percentage measures how much gross profit a company generates for each dollar of revenue earned.
It is calculated by taking gross profit and dividing it by total revenue. The result is expressed as a percentage.
For example if a company has $100,000 in revenue and $40,000 in gross profit the gross profit percentage is 40% ($40,000 gross profit / $100,000 revenue).
Gross profit is simply revenue minus the direct costs to produce the goods or services sold by the company It does not include operating expenses or taxes,
Knowing the gross profit percentage allows companies to evaluate the profitability of their products before accounting for other business costs. The higher the percentage, the more efficient the business is at producing its offerings.
Why Calculate Gross Profit Percentage?
There are several important reasons to calculate gross profit percentage:
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Assess product profitability – the metric shows directly which products are producing adequate gross profit to justify their production and sales. Products not meeting a target gross profit percentage may need to be discontinued or adjusted.
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Benchmark competitor performance – comparing your gross profit percentage to competitors reveals how efficient you are relative to others in your industry.
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Identify trends over time – significant changes in gross profit percentage over time can indicate issues with production costs or pricing that need investigating.
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Evaluate business or department performance – the metric can be calculated for the entire company or individual business units to compare their profitability.
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Price setting – an expected gross profit percentage can guide pricing decisions to achieve a desired profit on each sale.
Knowing how to calculate and interpret gross profit percentage gives business leaders important insights into their operations. Next I’ll go through the calculation step-by-step.
How to Calculate Gross Profit Percentage
The formula to calculate gross profit percentage is:
Gross Profit Percentage = (Total Revenue – Cost of Goods Sold) / Total Revenue x 100%
Let’s look at what comprises each element:
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Total revenue – This is the total income from sales of products and/or services before any expenses are deducted. It should include all sources of sales revenue for the period.
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Cost of Goods Sold (COGS) – This represents the direct costs attributable to production. It includes raw materials, labor, manufacturing overhead, and any other production-related expense. It does not include operating expenses like marketing, R&D or administration.
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Gross Profit – Revenue minus COGS. This represents the profit left over after subtracting production costs.
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Percentage – The gross profit as a percentage of total revenue, calculated by dividing gross profit by total revenue.
Let’s walk through an example to see how the calculation is performed.
Gross Profit Percentage Example
Consider a company with the following income statement for the year:
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| Revenue | $1,000,000 |
|---|---|
| Cost of Goods Sold | $600,000 |
| Gross Profit | $400,000 |
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The gross profit percentage would be calculated as:
Gross Profit Percentage = ($1,000,000 – $600,000) / $1,000,000 x 100%
Gross Profit Percentage = 40%
This indicates that for every $1 of revenue, the company retains $0.40 after accounting for the costs directly related to producing its products/services.
The key things to notice are:
- Only revenue and COGS are used, no other expenses
- COGS must contain all direct production costs
- The result expresses gross profit as a percentage of total revenue
Let’s look at another example for additional practice.
A company has $500,000 in revenue. Its COGS are raw materials of $120,000, direct labor of $100,000, and production overhead of $50,000. What is its gross profit percentage?
Revenue = $500,000
COGS = Raw materials + Direct labor + Production overhead
= $120,000 + $100,000 + $50,000 = $270,000
Gross profit = Revenue – COGS = $500,000 – $270,000 = $230,000
Gross profit percentage = Gross profit / Revenue x 100%
= $230,000 / $500,000 x 100% = 46%
Therefore, this company’s gross profit percentage is 46%. This means for every $1 in sales, it has $0.46 left over after paying the variable costs to produce its products.
Comparing to Gross Margin
Gross profit percentage is closely related to gross margin, but they have a subtle difference:
- Gross profit percentage – Gross profit as a percentage of revenue
- Gross margin – Gross profit expressed as a percentage of COGS
For example, using the revenue and COGS data from the examples above:
- Gross profit percentage = $400,000 Gross profit / $1,000,000 Revenue = 40%
- Gross margin = $400,000 Gross profit / $600,000 COGS = 66.67%
So gross margin shows gross profit as a percent of production costs, while gross profit percentage shows it as a percent of total revenue.
Both metrics are useful indicators of profitability. Gross margin measures production efficiency, while gross profit percentage measures the percent of sales revenue retained as profit after accounting for COGS.
Using Gross Profit Percentage
Once you have calculated gross profit percentage, here are some ways to use it:
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Compare percentage to industry averages to see if your business is competitive
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Set a target percentage appropriate for your profit goals
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Break down percentages by product line or division to identify high/low-performing areas
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Compare current period percentages to past periods to identify positive/negative trends
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Re-evaluate products or services with low gross profit percentages
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Use percentages in break-even analysis to determine required sales volumes
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Make pricing decisions based on achieving a desired percentage for each product
Regularly monitoring and comparing your business’s gross profit percentage helps spot issues with product costs or pricing. It is one of the most fundamental metrics for assessing product and business profitability.
Being able to accurately calculate and interpret gross profit percentage is an essential finance and accounting skill. This metric reveals how efficiently a business is utilizing materials, labor, and overhead in their production processes. It is a top-level indicator of product profitability.
In this guide, we walked through:
- What gross profit percentage measures
- Why it is an important metric
- The formula and calculation steps
- How it differs from gross margin
- Applications for driving business decisions
Operating Profit Margin
A company’s operating profit margin or operating profit indicates how much profit it generates under its core operations by accounting for all operating expenses. This type of profit margin takes additional expenses into account, such as interest and expenses.
This metric is calculated by subtracting all COGS, operating expenses, depreciation, and amortization from a company’s total revenue. Like the gross and net profit margins, the operating profit margin is expressed as a percentage by multiplying the result by 100.
How Gross Profit Margin Works
Gross profit is the total profit a company makes after deducting the cost of doing business. Put simply, gross profit is a company’s total sales or revenue minus its COGS. This figure is expressed as a dollar value. Gross profit margin, on the other hand, is the profit a company makes expressed as a percentage using the formula above.
It is one of the key metrics that analysts and investors watch, as it helps them determine whether a company is financially healthy. Companies can also use it to see where they can make improvements by cutting costs and/or improving sales. The sales and COGS can be found on a company’s income statement. A high gross profit margin is desirable and means a company is operating efficiently, while a low margin is evidence that there are areas that need improvement.
Product pricing adjustments may influence gross profit margins. With all other things equal, a company has a higher gross margin if it sells its products at a premium. But this can be a delicate balancing act because if it sets its prices overly high, fewer customers may buy the product. As a result, the company may consequently hemorrhage market share.
A wildly fluctuating margin may signal poor management and/or inferior products. But these changes may be justified when sweeping operational changes are made. As such, any temporary volatility shouldn’t be a concern. For instance, the initial investment may be high if a company automates certain supply chain formations, but the cost of goods ultimately decreases due to lower labor costs associated with the automation.
It’s important to compare the gross profit margins of companies that are in the same industry. This way, you can determine which companies come out on top and which ones fall at the bottom.
How to Calculate Gross Profit Margin Easy Trick – Profits Tips and Tricks
What is gross profit percentage?
Gross profit percentage is a measure of profitability that calculates how much of every dollar of revenue remains after paying off the Cost of Goods Sold (COGS). In other words, it measures the efficiency of a company utilizing its input costs of production, such as raw materials and labor, to produce and sell its products profitably.
How to calculate gross profit?
The gross profit is calculated by deducting the cost of goods sold from the total sales. Finally, it is calculated by dividing the gross profit by the total sales, as shown below. It is expressed in percentage, as the name suggests. Let us understand the concept with the help of a simple example to understand it better.
How do you calculate gross profit margin?
This requires first subtracting the COGS from a company’s net sales or its gross revenues minus returns, allowances, and discounts. This figure is then divided by net sales to calculate the gross profit margin in percentage terms. Analysts use a company’s gross profit margin to compare its business model with that of its competitors.
What is a gross profit ratio?
Gross profit percent = (gross profit ÷ net sales revenue) x 100 The gross profit ratio is an important financial measurement that evaluates profitability. Companies can calculate the gross profit margin to understand how efficiently costs generate sales. The gross profit ratio can also provide insight into operational efficiency.
