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What is gross profit margin?
Gross profit margin, also referred to as gross margin, is a measure of a company’s profitability. Gross profit margin indicates the amount of revenue remaining in a given accounting period after a company pays for labor and materials, otherwise known as cost of goods sold (COGS).
A company’s gross profit margin is the most basic measure of a company’s profitability: how much money is left after accounting for the cost of producing goods and services and paying workers. Businesspeople and investors generally hope to see a stable or growing gross profit margin; when this measure is shrinking, either the business is investing in its operations or it has a problem.
Gross profit margin is computed by dividing the difference between total revenue and the cost of goods or services sold by total revenue, and is generally represented as a percentage.
Gross profit margin = (total revenue – cost of goods sold) / total revenue x 100
When calculating gross profit, costs related to selling, administration, taxes, and certain other expenses are excluded. Net income or net income margin represents the profits available from a business after all expenses have been accounted for. Operating margin calculations add in certain additional costs, excluding debt payments and taxes.
Not sure whether or not you’re pricing your products and services right? Find out your gross profit margin with this calculator.
Gross profit margin example
Brewing powerhouse Duff Beer reported $10 million in total revenue for the year of 2016, while its cost of goods sold was $9 million — including fixed costs, materials costs and labor costs. Using the formula given above, we can easily calculate Duff Beer’s gross profit margin:
($10 million – $9 million) / $9 million x 100 = 12.5 percent
Generally speaking, a beer company with a gross profit margin of 12.5 percent is considered financially healthy, although it’s worth noting that each industry has a different gross profit margin rate that’s considered positive.