How to calculate gross margin
The cost of goods sold is a value that reflects the total costs directly related to the sale of products or services of the relevant company. Costs covered by this part of the revenue section include purchases, discounts on purchases, freight charges and other costs directly related to the sale of products or services.
Gross profit is a net result obtained by subtracting the value of goods sold from the net amount of sales. Gross profit shows how much money the company receives directly from the sale to other current expenses. Gross profit in monetary terms is calculated by subtracting the value of goods sold from net income. The gross profit ratio is a coefficient calculated by dividing gross profit by net income. Observing the change from year to year of the gross profit ratio allows you to make a fairly completethe idea of the potential for growth of the company's profit, related to the most important sources of its revenues.
How to calculate the gross margin ratio? The gross profit ratio can be calculated by dividing the company's gross profit by the net amount of its sales:
Gross Profit Ratio = Gross Profit - Net Sales
The gross profit ratio, expressed as a percentage, is the difference between sales revenue and costs directly related to making these sales, and is a good indicator of how efficiently a company uses its resources related to production, purchasing, and distribution to arrived. The higher this percentage, the more effective the company uses its resources and the more efficiently it makes a profit.
Comparing the gross profit ratios of different companies belonging to the same industry or sector of the economy, you can get a fairly complete idea of how effectively a company earns a profit. Investors prefer more efficient companies.
To help you understand how to use this coefficient, as well as other factors that will be discussed in this chapter, we will compare the performance of the two leaders in the retail sector of household goods and household goods: the Note Depotm Lowe ’. In tab. 6.1 and 6.2 represent the gross profit of these two companies for the period from 2001 to 2003. . In tab. 6.3 compares the gross profit margins of these two companies.
It is clear from the last table that Note Depot turned out to be somewhat more efficient than Lowe ’in terms of utilizing its production, purchasing and distribution resources, since Note Depot’s gross profit margins are consistently higher than Lowe’s. Both companies, however, show a tendency to improve. The advantage of using this coefficient to compare the effectiveness of companies is that it significantly simplifies the task of comparing large and small companies related to the same industry or the same sector of the economy. Despite the fact that the sales volume of Note Depot company more than twice exceeds the sales volume of Lowe 'company, this coefficient allows us to compare the efficiency of using the resources of the two companies.
The next section of the profit and loss account reflects the costs associated with running a business, including trade costs and administrative costs of doing business. Comparing the results of the company for individual years, one should pay attention to whether the expenses of the company are increasing faster than its gross profit. If the company's expenses increase faster than its gross profit, this may indicate that the company is not able to effectively control its expenses, which in turn does not bode well in terms of future growth in its profits.
When you see that the company's expenses are declining year by year, and gross profit is rising, this is a good sign, which indicates that this company has a clear cost control program. Such a company has a good potential for increasing gross profit.
When gross margins and company expenses rise at the same rate, this is neither a positive nor a negative sign. In this case, the best way to assess the effectiveness of the company's control over its expenses is to compare its costs with the costs of other companies of a similar profile.
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