Gross Profit Ratio

Gross Profit Ratio is a type of Profitability Ratio that determines the mathematical relation between Gross Profit and Revenue from Operation. It indicates the Gross Margin on Products sold.
Gross Profit Ratio = Gross Profit / Net Sales
Where,
  • Gross Profit = Revenue from Sales – Cost of Goods Sold (COGS)
  • And Net Sales is the Total Revenue from Sales.
  • Gross Profit Ratio multiplied by 100 provides the Gross Profit Margin in percentage Terms.

Significance and Interpretation

  • It is very important for an industry to maintain a stable Gross Profit Ratio, frequent variations in the ratio points towards its instability.
  • High Gross Profit Ratio is expected by every company to indicate high profits. Factors that affect the Gross Profit Ratio are as following:
    • High Price: The high price of a product will directly influence the profit associated, keeping the manufacturing costs at the same level. Higher Price of a product may be due to several reasons as below:
      • Superior Products (6GB RAM vs 2GB RAM)
      • Brand Value (e.g. Samsung vs Vivo)
      • Use of Technology (Magnetic Hard Disk vs Solid State Drives)
    • Low Product Cost: Cost of Goods Sold (COGS) directly affects the Gross Profit of the company, a low COGS indicates Higher Gross Profit Ratio.

Examples

Example 1: Given below are few details of M/S XYZ Ltd., use them an calculate the Gross profit ratio for M/S XYZ Ltd.
Particulars Amount (in Rs.)
Revenue from Sales (Cash) 100000.00
Revenue from Sales (Credit) 55000.00
Cost of Labour 40000.00
Material Cost 45000.00
  • Solution:
  • Net Sales Revenue = Cash Revenue from Sales + Credit Revenue from Sales = Rs. 155000.00
  • Cost of Goods Sold = Cost of Labour + Material Cost = Rs. 85000.00
  • Gross Profit = Net Sales Revenue – Cost of Goods Sold = 155000 – 85000 = Rs. 70000.00
  • Gross Profit Ratio = Gross Profit / Net Sales Revenue = 70000 / 155000 = 14 / 31
  • Hence, Gross profit Ratio = 14/31 or 0.4516 or 45.16%
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