The gross profit margin ratio shows the percentage of sales revenue a company keeps after it covers all direct costs associated with running the business. It is one of five calculations used to measure profitability. The others are return on shareholders’ equity, the net profit margin ratio, return on common equity and return on total assets.
Gross profit margin is calculated by subtracting direct expenses from net revenue, dividing the result by net revenue and multiplying by 100%.
(Net revenue – direct expenses) Net revenue
x 100% = Gross profit margin ratio
A higher gross profit margin, means the company has more cash to pay for indirect and other costs such as interest and one-time expenses. This makes it an important ratio for helping business owners and financing professionals assess a company’s financial health.
The gross profit margin ratio is typically used to track a company’s performance over time or to compare businesses within the same industry.
More about the gross profit margin ratio
From the income statement below, ABC Co.’s net revenue is $100,000 and direct expenses are $35,000, so its gross profit margin ratio would be as such:
($100,000 – $35,000) / $100,000 x 100% = 65%
A gross profit margin ratio of 65% is considered to be healthy.