Gross Profit Ratio : Gross Profit Margin Analysis

The gross profit ratio tells gross margin on trading. It is the gross profit expressed as a percentage of total sales and calculated as follows:

Gross profit is taken before tax and other indirect costs.Net sales means that sales minus sales returns. Gross profit would be the difference between net sales and cost of goods sold. Cost of goods sold would be equal to opening stock plus purchases, minus closing stock plus all direct expenses relating to purchases.

For example if gross profit is Rs.60,000 and net sales are Rs.4,00,000, the gross profit ratio will be calculated as follow:

It is better the higher ratio. A low ratio indicates unfavourable trend in the form of reduction in selling prices not accompanied by proportionate decrease in cost of goods or increase in cost of production

Causes of increase or decrease in gross profit ratio:

An increase in the GP ratio may be due to the following reasons:

• Increase in the selling price of goods sold without any increase in the cost of goods sold.
• Decrease in cost of goods sold without any decrease in selling price.
• Omission of purchase invoices from accounts.
• Under valuation of opening stock or overvaluation of closing stock.

The decrease in the gross profit ratio may be due to the following reasons:

• Decrease in the selling price of goods, without any decrease in the cost of goods sold.
• Increase in the cost of goods sold without any increase in selling price.
• Unfavorable purchasing or markup policies.
• Inability of management to improve sales volume, or omission of sales.
• Over valuation of opening stock or under valuation of closing stock

NEXT – Profitability Indicator Ratios: Operating Profit Ratio

Table of Contents
1) Profitability Indicator Ratios: Introduction
2) Profitability Indicator Ratios: Gross Profit Ratio
3) Profitability Indicator Ratios: Operating Profit Ratio
4) Profitability Indicator Ratios: Net Profit Ratio
5) Profitability Indicator Ratios: Return on Capital Employed
6) Profitability Indicator Ratios: Return on Equity
7) Profitability Indicator Ratios: Return on Assets