What is the Gross Profit Percentage?
The gross profit percentage is the gross profit (sometimes called gross margin) of the business expressed as a percentage of the revenue. It is a measure of the level of true income a business generates on its sales. It is calculated by dividing gross profit by revenue.
Formula for Gross Profit Percentage
- Gross Profit is found in the profit and loss statement. It is the difference between revenue and cost of goods sold.
- Revenue is also found in the profit and loss statement. It may be called Sales or Turnover.
How do you calculate Gross Profit Percentage?
Suppose a business generates a gross profit of 144,000 from revenue of 240,000, then the gross profit percentage is 144,000 / 240,000 x 100% = 60%.
The same process can be applied to an individual product included within sales. If a product sells at 75 and the cost of the product is 45, then the gross profit for the product is 75 – 45 = 30, and the gross profit percentage is 30 / 75 x 100% = 40%.
What does the Gross Profit Percentage show?
The gross profit percentage shows how much of the revenue is left after deducting the cost of sales. This amount has to be sufficient to cover the overheads of the business for it to be profitable.
In the first example above, the gross profit was 144,000 or 60% of sales, if the overheads of the business are more than this then the business will make a loss.
Useful tips for using the Gross Profit %
- The gross profit percentage will vary from industry to industry, so it is important to make comparisons to similar businesses in your sector. If your gross profit percentage is substantially different from other businesses within your sector it will need investigation to ascertain why. A low gross profit % might indicate that your selling prices are too low or your costs are too high compared to competitors. A much higher gross profit percentage relative to competitors may indicate that you have not fully understood your costings and items have been omitted.
- The aim is to get the gross profit percentage as high as possible. This could be achieved by reducing the cost of the product by design or production efficiency, or by increasing the selling price, if the market will permit.
- The gross profit percentage is useful for comparing which products should be purchased or produced given limited resources. If one product has a selling price of 75 and a gross profit of 30, and another product has a selling price of 95 and a gross profit of 45, then by comparing the gross profit % it is easy to see which product is the most profitable.
|Prod 1||Prod 2|
|Cost of sales||45||50|
|Gross profit %||40.0%||47.4%|
In the example above Product 2 is more profitable with a gross profit % of 47.4% and should take preference if resources are limited.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.