The gross profit percentage is the gross profit of the business expressed as a percentage of the revenue. Furthermore 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. Additionally the gross profit percentage is sometimes referred to as the gross margin.
Formula for Gross Profit Percentage
- Gross Profit is from the income statement. It is the difference between revenue and cost of goods sold.
- Revenue is also from the income statement. Additionally 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%.
Additionally the same process is applicable to an individual product included within sales. If a product sells at 75 and the cost of the product is 45, then the profit for the product is 75 – 45 = 30, and the profit percentage is 30 / 75 x 100% = 40%.
What does the Gross Profit Percentage show?
The profit percentage shows how much of the revenue is left after deducting the cost of sales. It is important to realize that 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
- 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 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. In contrast a much higher profit percentage relative to competitors may indicate that you have not fully understood your costings and items have been omitted.
- It must be remembered that the aim is to get the profit percentage as high as possible. Accordingly 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.
- Finally 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 | |
|---|---|---|
| Selling price | 75 | 95 |
| Cost of sales | 45 | 50 |
| Gross profit | 30 | 45 |
| Gross profit % | 40.0% | 47.4% |
As can be seen in the example above Product 2 is more profitable with a gross profit % of 47.4% and should take preference if resources are limited.