A Gross Profit (GP) is the difference between the Buying Price or Cost of Goods without any overheads or selling costs, and your own Selling Price, and it is expressed as a percentage of that Selling Price. The GP margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor, who wishes to put money into the company, the percentage of revenue or sales left after subtracting the cost of goods sold (ie. The gross); a company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, having scanned the market for a suitable place to invest in, as these businesses should be able to make a decent profit as long as overhead (rent, utility and necessary) costs are controlled and staff payments are factored into the equation. To calculate gross profit margin, use the formula: GROSS PROFIT divided by TOTAL REVENUE and then multiply that number by 100 per cent. The gross margin tends to remain stable over time. Significant fluctuations can be a potential sign of fraud or accounting irregularities. If you are analyzing the income statement of a business and gross margin has historically averaged around three to four per cent, and suddenly it shoots upwards of 25 per cent, you should be seriously concerned. In an example, should a company receive $25,000 in sales and its cost of goods sold were $20,000, the gross profit margin would be equal to [$25,000 minus $20,000] divided by $25,000, or 20 per cent (five divided by 25, with cancellations, times 100 per cent). In layman’s terms, 20 per cent gross profit margin means that for every dollar generated in sales, the company has 20 cents left over to cover basic operating costs and profit.
