Gross profit margin
profitsThe amount of money made after all expenses have been paid. calculations alone are of limited use. While gross profitGross profit is the difference between the money received from selling goods and services and the cost of making or providing them. It ignores any fixed costs or overheads. can be compared over time to see whether products have become more or less profitable, additional information is needed to assess whether a business has performed well.
For example, if their gross profit figure doubled over the period of a year, most businesses would be pleased. However, this may not tell the full story:
| Gross profit | Sales revenue | |
| Last year | £50,000 | £150,000 |
| This year | £100,000 | £450,000 |
| Last year | |
| Gross profit | £50,000 |
| Sales revenue | £150,000 |
| This year | |
| Gross profit | £100,000 |
| Sales revenue | £450,000 |
The table shows that although the gross profit doubled this year compared to last year, in the same period the sales revenueThe money received from selling goods and services. tripled. As such, the business might want to understand why the gross profit did not also triple.
In order to better assess the performance of a business, it is necessary to calculate the profit marginThe difference between sales revenue and total costs expressed as a percentage.. Profit margin is the amount of profit expressed as a percentage of sales revenue. Since there are two different measures of profit, there are also two different types of profit margin: gross profit margin and net profit margin.
Gross profit margin
The gross profit marginThe percentage of sales revenue that is left once the cost of sales has been paid. is the percentage of sales revenue that is left once the cost of salesThe variable costs incurred as a direct result of making a product or providing a service, eg raw material costs. has been paid. It tells a business how much gross profit is made for every pound of sales revenue received. For example, a gross profit margin of 75% means that every pound of sales provides 75 pence of gross profit.
Where a business is able to provide significant added valueThe difference between the cost price and selling price., then the gross profit margin will be higher. Examples include handmade goods and specialist services.
Calculating the gross profit margin
In order to calculate the gross profit margin, a business will use the following formula:
\(\text{Gross profit margin (\%)}=\frac{\text{Gross profit}}{\text{Sales revenue}}\times100\)
In the example given in the table above, the gross profit margins for this year and last year would be:
| Gross profit | Sales revenue | Gross profit margin (%) | |
| Last year | £50,000 | £150,000 | (£50,000 ÷ £150,000) × 100 = 33.33% |
| This year | £100,000 | £450,000 | (£100,000 ÷ £450,000) × 100 = 22.22% |
| Last year | |
| Gross profit | £50,000 |
| Sales revenue | £150,000 |
| Gross profit margin (%) | (£50,000 ÷ £150,000) × 100 = 33.33% |
| This year | |
| Gross profit | £100,000 |
| Sales revenue | £450,000 |
| Gross profit margin (%) | (£100,000 ÷ £450,000) × 100 = 22.22% |
This shows that the gross profit margin for this business decreased from 33.33% to 22.22% over this year (rounded to 2 decimal places).
Using the gross profit margin
Comparing gross profit margins over time can be useful for businesses. In the example above, the gross profit margin decreased despite the fact that the sales revenue tripled and gross profit doubled. This indicates that the cost of sales, which includes raw materials, increased faster than the business increased the price it charged its customers. This business might respond by increasing the price that it charges its customers or by negotiating lower prices for raw materials with its suppliers.
Question
A business that manufactures sportswear sold £5,000,000 worth of products last year, compared to sales of £6,000,000 this year. Last year it made a gross profit of £2,500,000, whereas this year its gross profit reached £4,500,000. Calculate the gross profit margin for this year and last year, and state in which year the business performed best.
\(\text{Gross profit margin (\%)}=\frac{\text{Gross profit}}{\text{Sales revenue}}\times100\)
| Gross profit | Sales revenue | Gross profit margin (%) | |
| Last year | £2,500,000 | £5,000,000 | (£2,500,000 ÷ £5,000,000) × 100 = 50% |
| This year | £4,500,000 | £6,000,000 | (£4,500,000 ÷ £6,000,000) × 100 = 75% |
| Last year | |
| Gross profit | £2,500,000 |
| Sales revenue | £5,000,000 |
| Gross profit margin (%) | (£2,500,000 ÷ £5,000,000) × 100 = 50% |
| This year | |
| Gross profit | £4,500,000 |
| Sales revenue | £6,000,000 |
| Gross profit margin (%) | (£4,500,000 ÷ £6,000,000) × 100 = 75% |
The sportswear manufacturer performed better this year, with a gross profit margin of 75%. This is better than the gross profit margin of 50% that it achieved last year.
