What is Gross Profit Margin? How to Calculate It for Business Efficiency

Concept and meaning of gross profit margin  

Gross Profit Margin is a financial ratio used to measure a company's operating performance. It shows the percentage of revenue remaining after subtracting the cost of producing the goods or services sold.

Meaning of gross profit margin: :

• There are several levels of profit that analysts look at to evaluate a company's performance. These include gross profit, operating profit, and net income. Each level provides a different view of a company's profitability. 
• Gross profit is the first measure of profit, providing analysts with insight into a company's ability to produce or provide a service compared to its competitors.
• Gross profit margin is calculated by dividing gross profit by revenue. This allows analysts to compare different business models with a quantitative metric.
• This ratio shows how much income each dollar of revenue generates. Gross profit margin is a useful metric when comparing businesses in the same industry.

Formula for calculating gross profit margin

Gross profit margin is calculated by the formula:    

Gross profit margin (%) = (Gross profit / Revenue) * 100%

In there: 

Gross Profit = Revenue - Cost of Goods Sold (COGS)

And in some cases, revenue can be replaced by net revenue. And the gross profit margin will be calculated using the formula:

Gross profit margin (%) = Gross profit / Net revenue

How to improve gross profit margin

Cut production costs:

As a business expands, it can order larger quantities, set up more favorable payment terms with suppliers, or increase production. These measures help reduce production costs.  

Using lower cost raw materials is also a way to reduce the cost of goods sold, thereby increasing the gross profit margin . However, this needs to be done carefully to avoid reducing product quality, causing loss of customers and reduced revenue.

 

Expanding production scale:

To save production costs while maintaining quality, many businesses choose to expand their production scale. This is an effective long-term strategy, helping to reduce the average cost of raw materials, machinery, labor and other assets. Expanding the scale helps save costs and improve the production capacity of the business.

Adjust selling price:

During tough economic times such as inflation, businesses may have to raise prices to maintain profits. When raising prices, businesses should monitor competitors’ prices to avoid losing customers to cheaper options. Raising prices gradually or giving customers advance notice can help users feel respected. At the same time, customers may be more likely to accept the new price.

Other profit margin formulas that businesses should consider

Net profit margin ROS

Net profit margin (ROS) represents the ratio of after-tax profit to revenue. This ratio is also known as return on sales. ROS is used to evaluate the operating efficiency of a company by determining the percentage of revenue converted into operating profit.

To calculate the ROS index, we take net profit (profit after tax) divided by net revenue. The specific formula is as follows:

ROS = (Profit after tax / Net revenue) x 100%

In there: 

• Net revenue: Actual sales revenue after deducting sales discounts.
• Profit after tax: Is profit before tax minus total tax payable and plus deferred taxes.

Return on Assets ROA

ROA is a measure of how efficiently a company uses its assets to generate profits. It shows how much profit a company can earn for each dollar of assets it invests.

ROA is calculated by dividing net profit after tax by total assets. The specific formula is as follows:

ROA = Profit after tax / Total assets

Return on Equity ROE

Return on equity (ROE) is a financial ratio that measures a company's ability to generate profits from the capital invested by its shareholders. ROE provides insight into the efficiency with which the company is using its equity and allows for comparison of the company's performance with that of its industry peers.

Here is the formula for calculating ROE ratio:

ROE = Profit after tax / Total equity

Hopefully with the above article, businesses will calculate and manage profit margins more effectively. If you have any questions about the financial management process, please contact us for detailed answers.