The financial ratio known as gross profit margin is a measure of a company's ability to profitably make a product or supply a service. The metric does this by comparing the impact the cost of goods sold has on revenues.
Gross Profit Margin = Gross Profits / Revenues
The gross profit margin can also be expressed in terms of a percentage as shown below:
Gross Profit Margin (%) = (Gross Profits / Revenues) x 100
When evaluating companies, analysts and investors look for a relatively high gross profit margin. High margins indicate the company may have an advantage such as the ability to demand premium pricing, a patent, or a trade secret that allows for low manufacturing costs. The above formula demonstrates that as the cost of goods sold approaches zero, the gross profit margin approaches 100%.
When drawing conclusions about the relative performance of a company, benchmark comparisons should be made with competitors in the same industry.
Company A's balance sheet indicates revenues of $29,611,000 and a cost of revenue (another name for cost of goods sold) of $15,693,000. Company A's gross profit margin would be:
= (($29,611,000 - $15,693,000) / $29,611,000) x 100
= ($13,918,000/ $29,611,000) x 100, or 47.0%