Let’s take a look at a significant measure of profit and profitability. It is the gross profit and the associated gross profit margin.
What is Profit Margin?
A starting point for calculating gross profit margin is gross profit. So what is it? The profit margin is the difference between the sales, the revenues that we earn and the specific costs of those sales revenues.
So-called cost of goods sold, it’s not all the costs of the business, it’s just the costs directly relating to those sales revenues.
For example, if we had sales revenues of say $400,000, and the cost of those sales was $150,000, then the gross profit is simply the difference between sales, revenue and cost of sales. $400,000, less $150,000 gives us a gross profit of $250,000, and that’s not the total profit of the business because we need to take off other costs that have overheads, but it’s a significant measure of profitability.
What is gross profit?
What’s the gross profit margin?
While the gross profit margin is expressed as a percentage and the formula it’s the gross profit number divided by the sales revenue number, and we get both of those two pieces of data from the income statement, sales revenue, total value of sales, gross profit, which as we’ve seen is sales revenue, less cost of sales, and we express the gross profit margin as a percentage. So looking at that from our, a simple example at the start of this video, the gross profit divided by the sales revenue, the gross profit we worked out with 250 pounds, a thousand pounds divided by the sales revenue of 400,000 pounds, always express as a percentage, so times by a hundred that gives us a gross profit margin of 62.5% now the gross profit margin is one of those margins that is really worth, worth investigating and examining, particularly when we’re comparing the performance of one business with another.
how does the gross profit margin compare with competitors ?
So not only do we need to look out for changes from one year to another and increase or decrease in the margin, but also how does the gross profit margin compare with competitors?
Because in theory they should have similar gross profit margins if the gross profit margin has fallen. There could be a number of reasons for this. It could be that the cost of good sales has gone up. Perhaps suppliers are charging as a higher price than could be connected to, for example, to a change in exchange rates or it could be that we’ve decided or we’ve been forced to sell at lower prices, thereby reducing the gross profit margin.
It could also be that on average we’ve sold more low margin products compare with high margin product, so a change in gross profit margin could often be an associated with a difference in the mix.
The types of products that we’re selling, if we see an increase in the gross profit margin, it can often the reverse, can’t it? It could be that we’ve been buying better from our suppliers.
We’ve maybe been able to negotiate a cost reduction on the cost of goods that we buy from them, or perhaps that we’ve been able to achieve an increase in selling prices with our customers without necessarily suffering and increasing costs. Okay. There we go. That’s just a very brief introduction to how we calculate gross profit and the associated ratio. The gross profit margin.