New and startup business owners need to monitor their company’s finances closely. Looking at your gross profit margin monthly or quarterly and keeping track of cash and inventory will help optimize your company’s performance. Monitoring your gross margin is vital to ensure your business is generating enough revenue for sustainability. But the net profit margin is the most definitive measure of a company’s profitability.

Firstly, note the company’s total sales, easily available as a line item in the income statement. COGSThe Cost of Goods Sold is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company.

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The How To Calculate Gross Profit Margin and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Investors often prefer to see gross profit as a percentage because it is easier to compare against other companies. Gross profit expressed as a value, as in the above case, is not that beneficial to many investors, and that is the reason why many companies put this ratio as a percentage.

Since only direct costs are accounted for in the metric, the gross margin shows how much in profits remains available for meeting fixed costs and other non-operating expenses. Most small businesses start as “flying by the seat of your pants” operations, with little use of data for decision making. As the business grows, however, it becomes essential to introduce ways of measuring and assessing various aspects of the business to ensure growth and profitability. The gross profit margin percentage is one of these basic and useful assessment tools.

Gross Profit Margins Are Industry-Specific

It gives a snapshot of a company’s profitability but needs to tell the full financial health story. It’s essential to look at other financial metrics such as net profit margin, return on assets, equity, and cash flow to understand the overall financial performance better. In simple terms, if a product sells for $5 and cost $2 to make, the gross profit for this item is $3 and its gross profit margin is 60% .

Gross profit can be calculated by subtracting the cost of goods sold from a company’s revenue. As such, it sheds a light on how much money a company earns after factoring in production and sales costs. The term gross margin refers to a profitability measure that looks at a company’s gross profit compared to its revenue or sales. The higher the gross margin, the more capital a company retains, which it can then use to pay other costs or satisfy debt obligations. The revenue or sales figure is gross revenue or sales, less the cost of goods sold , which includes returns, allowances, and discounts. Among the many metrics used in financial analysis and corporate performance management, gross profit margin is one of the most widely used.