The gross profit margin measures how much gross profit is generated for each dollar of sales. The gross profit has to cover the company’s operating expenses, depreciation and amortization, finance cost, and taxes. Gross profit margin will vary significantly between companies in different industries. For example, companies with significant fixed assets will typically have a higher gross profit margin than companies with low fixed assets such as service companies.
A change in the company’s gross profit margin could be a result of price pressure from competitors, meaning that the company maintains the current cost structure while lowering sales prices. It could also be a result of higher cost of sales. This could be true if goods are imported, which typically adds another layer of expenses to the cost of sales, that is, fluctuations in foreign currents. Often, it can also be explained with a shift in product mix. It is therefore important to look at the gross profit margin on each product or product line.
Formula for Gross profit margin
\[Gross\,profit\,margin= \frac{{Sales-Cost\,of\,goods\,sold}}{{Sales}}\]
Example
HDFC has sales in the amount of Rs.210,000 and cost of sales in the amount of Rs.163,000, which gives a gross profit margin of 22.38%. A gross profit margin of 22.38% means that for each Rs.100 of sales generated by the company, Rs.22.38 is gross profit to cover the company’s operating costs.
