Gross profit or Gross margin are considered as a backbone of any business. Calculation of gross profit and gross margin percentage is very critical in its nature. If someone is looking for more investment for his business either in form of loan from a bank or by selling business shares to the investor, in both cases, they are asked for the gross margin percentage.Gross profit is composed of two things i.e. “revenue generated from the selling
of products minus cost incurred to make products”.Whereas gross margin percentage might be calculated as “gross margin divided by selling price of product”. High gross margin percentage makes your business more valuable and attracts outsiders to attach with your business. For example: Assume one unit selling price as 100$ and cost to manufacture it as 20$ gives you a gross margin of 80$ and gross margin percentage of 80% which is considered to be a good percentage.
Gross margin percentage varies from industry to industry. It can be used to analyze the current market values in which your company operates. Company’s current position can also be compared with its previous year’s working to capture the fluctuations in prices.
Computation of gross margin
For the calculation of gross margin, pure figures of net sales/revenue and cost of goods sold should only be taken. Any other indirect cost or shareholder’s dividend must not be taken into this calculation. A financial statement of the company shows these figures which can be used to calculate this.
Calculation of net sales
Net sales comprise of revenue generated from the selling of products after deduction of sale discounts, sale return and allowance for spoiled inputs. It does not involve distribution and selling costs in the calculation. This gives the truer picture of revenue instead of the only sale amount.
Determination of costs of goods sold
It can also be abbreviated as CGS. CGS comprises of costs from the purchase of raw material up to the production of finished products. It includes the figures that directly relate to the manufacturing of products i.e. purchase of raw material, a cost incurred to bring raw material to production premises, packing material, indirect labor cost (cost of daily wages workers only) and any other cost that directly relate to the manufacturing process. The cost incurred to bring products to the market for sale must be excluded from direct cost.
Classify between gross profit and gross profit percentage
Gross profit simply shows the figures in terms of currency that may be in dollars or currency in which country your business is operating while the gross percentage shows the figures in percentage to allow users to make the comparison with competitors’, market situations or to know business performance with previous years.
Recognition from the figures
Investors in the stock market analyze the gross profit percentage before buying shares of a company to know the worth of business and same in the case of the loan from banks. Investors prefer to invest in companies with high GP percentage as compared to the low ones. For example: Suppose company A makes a GP percentage of 80% while the company B which is also a competitor of company A makes a GP percentage of 60%, the definite investor will wish to invest in company A as the other indirect expenses assumed to occur probably at the same level.