Gross Profit Margin

The gross profit margin is the amount left over from sales after the cost of goods sold is subtracted.

Gross profit is the earliest measure of business strength before operating and other expenses are subtracted.

 

 

How to Calculate Gross Profit Margin

Gross Margin = (Sales – COGS)/Sales

Sunny sells a pair of sunglasses for $50 retail. Sunny is able to purchase these sunglasses for $15 each wholesale (COGS). Sunny Sunglasses Shop therefore made a healthy gross profit of $35 (50 – 15 = 35). This translates into a strong gross margin of 70% (35/50 = 70%).

In analyzing how Sunny achieved a net profit in his business, the gross profit margin is a key measurement. Sunny managed to negotiate a competitive wholesale price for a quality product that retails for $50.

A strong gross margin is crucial to business success since it represents profit before operating expenses and taxes enter the picture. Let’s see how Sunny Sunglasses Shop’s gross profit margin compares with other companies and its industry, Specialty Retail, Other:

Industry Ratios: Gross Profit Margin

Company	Average Gross Profit Margin
Microsoft	77.2%
Software Industry	75.6%
Sunny Sunglasses Shop	70%
Sunglasses Hut Int. (Luxottica Group)	65.6%
Specialty Retail, Other	42.5%
S&P 500	39.6%

Sunny wisely selected a business with a strong gross margin, getting his profits off to a jump-start before operating expenses and taxes. It is right in line with his closest and largest competitor, Luxottica, and well ahead of the industry average of 42.5% for Specialty Retail.

Information Products and Strong Gross Margins

Many software companies, or makers of other information products, have strong gross margins because the cost of goods sold is very low in comparison to other industries that require more expensive inventories. Microsoft is known for its strong gross margins of around 80%! The software industry average is 75.6%, while the S&P 500 average is 39.6%! A strong gross profit margin is essential to getting a jump-start on profits, and should be one of the first considerations in starting your business!

Sunny should monitor this key indicator of gross profits from year to year to ensure he remains profitable, and note any reasons why his gross margins are going up (e.g. wholesale discounts, in demand products and higher prices) or down (e.g. more expensive inventory, discounted retail items, and lower demand for products).

A small percentage of Sunny Shop’s customers will return products sold. Note that gross profit is divided by sales after returns, or net sales, not gross sales.

Sunny selected a business with an impressive gross margin. His next step is to make sure he holds on to his profits by controlling operating expenses.

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