• HDFC securities
• 13 Jan 2023
• Knowledge Centre

Understanding financial ratios and reports are crucial for an investor or business owner. Having a good understanding of financial ratios can help an investor meticulously study the company and monitor its performance. There are several important ratios that can help analyse various aspects of a company. One such ratio is the Gross Profit Ratio

What is the Gross Profit Ratio?

The Gross Profit Ratio is a measure of profitability that expresses the company’s gross profit as a percentage of its total sales. In simpler terms, the ratio helps in knowing the profit that a company makes after deducting the direct costs and expenses.

It is one of the most important profitability ratios used to evaluate a company's financial performance. Learning how to calculate the gross profit ratio can help us understand this better.

Gross Profit Ratio Formula

To calculate the gross profit ratio, we need to subtract the cost of goods sold from the net sales and divide it by the total net sales.

Gross Profit Ratio = (Net sales – Cost of goods sold) / Net sales

Let us look at the different terms which can help us in calculating the gross profit ratio.

Net Sales: Net sales refer to the total sales of the company after deducting the goods that have been returned.

Cost of goods sold: All the direct expenses that are incurred during the process of production like the materials and labour costs are included in the costs of goods sold.

With the help of an example, we can further understand how the gross profit ratio is calculated.

If a company has net sales of Rs 50,000 and the cost of goods is Rs 35,000 then the gross profit ratio will be calculated as follows.

GPR = (50000-35000)/50000

         = (15000)/50000

         = 0.3 or 30%

Therefore, we conclude that the gross profit ratio of the company is 30%.

Importance of Gross Profit Ratio

The gross profit ratio is important because it can help in the following ways:

• The gross profit ratio is a helpful metric used to measure a company’s efficiency and analyse sales revenue and performance.
• Investors compare the gross profit ratio of a company with its peers. Companies that show steady growth in the ratio have an advantage over their competitors.
• The ratio can also be helpful in making pricing decisions. A company can use the gross profit ratio to price their goods in a way that can help them maintain profits while gaining market share.
• Business owners can use the gross profit ratio to monitor the performance and make necessary changes in the business operations. Certain areas of focus can be improved, and it can also help in reducing costs. Companies with several products can use this ratio to find out which products are performing better than others.

In conclusion, calculating the gross profit ratio is easy if the necessary data is available. Furthermore, knowing the meaning of gross profit ratio can help investors in analysing the company’s performance and efficiency and making important investment decisions.