How To Calculate The Gross Profit Percentage

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Cost of Goods Sold (COGS) Operating Expenses SG&A Expenses Cost of Goods Sold vs. Operating Expenses Cost of Goods Manufactured (COGM) Research and Development (R&D) Direct vs. Indirect Expenses Overhead Expenses

How To Calculate The Gross Profit Percentage

How To Calculate The Gross Profit Percentage

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The gross profit metric reflects the earnings that remain after a company’s cost of goods sold (COGS) is subtracted from its net income.

More specifically, the gross profit metric is the revenue that remains after all direct costs associated with producing a good or delivering a service to generate sales have been subtracted from revenue.

On the income statement, the gross profit line item appears below the cost of goods sold (COGS) line, which comes immediately after revenue (ie, the “top line”).

Conceptually, the gross income metric thus reflects the profit available to cover fixed costs and other non-operating expenses.

Gross Profit Percentage On Sale

As a stand-alone metric, gross income isn’t too meaningful. Hence, the profit metric must be standardized by converting it into a percentage form.

The formula for gross margin is the company’s gross profit divided by revenue for the relevant period.

Gross margin is the percentage of a company’s revenue that remains after subtracting COGS (eg direct materials, direct labor).

How To Calculate The Gross Profit Percentage

In addition, gross margin facilitates comparisons between industry peers and comparable companies, as well as for performing year-over-year (YoY) analyses.

What Is A Good Gross Profit Margin?

The classification of a company’s gross profit as “good” is entirely dependent on the industry in which the company operates and related contextual details. But before comparisons can be made, gross profit must be standardized by dividing the metric by revenue.

Therefore, similar to the use of valuation multiples in comp analysis, gross profit must be converted to a percentage, ie gross margin, as we illustrated earlier.

In general, higher gross margins are more often than not perceived positively, as the potential for higher operating margins (EBIT) and net profit margins in such cases increases. But to reiterate, comparisons of company gross margins must only be made between comparable companies (ie, apples to apples).

As a real-world example, Apple’s (NASDAQ: AAPL ) dollar amount gross margin from fiscal 2019 to 2021 is as follows.

How To Calculate The Gross Profit Ratio

Note: Apple’s income statement reports gross margin, rather than gross profit. While most tend to associate gross “margin” with profit margin, ie. percentage or ratio, others use the two terms interchangeably.

In recent years, Apple has shifted its focus from selling hardware to software, especially as it has become increasingly difficult for Apple to provide enough incentive for customers to upgrade to newer hardware models (ie, a phone or laptop).

Unlike software and related services—which represent sources of recurring revenue—hardware products are one-time purchases.

How To Calculate The Gross Profit Percentage

Therefore, given the larger total addressable market (TAM) for software, the rationale for Apple’s shift towards strengthening online service offerings and integrating the Apple ecosystem (eg iOS App Store, iCloud, iTunes, Apple Music, Macs) not surprisingly.

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On the other hand, the net income – ie. The “bottom line” of the income statement – is a profit metric that includes all expenses, including operating expenses such as COGS and SG&A, as well as non-operating expenses such as interest and taxes.

While the gross income metric only covers COGS, net income is an impacted (ie, post-debt) metric because it is affected by interest expense and can only be attributed to shareholders who own equity in the company.

One major drawback of the net income metric – apart from the fact that it is a profit after debt metric – is that net income can also be distorted by non-operating income / (expenses), such as interest income, interest expense, profits or losses on sales of assets, and inventories or write-offs of PP&E.

In contrast, a company’s gross profit subtracts only one cash outflow, the direct costs associated with core revenue.

The Importance Of Understanding Gross Profit Percentage

The gross income metric is far more appropriate for peer comparisons because it is largely unaffected by financing decisions or discretionary accounting policies (eg, PP&E useful life assumptions that determine annual depreciation expense, jurisdictional tax differences rate, NOLs).

In order to predict a company’s gross profit, the most common approach is to make an assumption regarding the company’s gross margin (GM) percentage based on historical data and comparable industry data.

Since this leaves the cost of goods sold (COGS) line blank, the next step would be to subtract projected gross revenue from revenue, which should result in COGS

How To Calculate The Gross Profit Percentage

An alternative approach is to subtract the gross margin from one to arrive at the COGS margin, ie. COGS as a percentage of revenue.

Percentage Of Completion Method

Suppose we are tasked with calculating Apple’s (AAPL) gross profit and gross margin for the last three fiscal years.

Historical net sales and cost of sales data reported for Apple’s most recent 10-K are reported in the table below.

In our model, we will calculate the gross profit and gross margin metrics separately for the product and service divisions.

The differences in gross margins between products versus services are 32%, 35% and 34% over the three-year time span, reflecting how services are much more profitable than physical products.

Markup Vs Gross Profit Percentage

In the final part of our modeling exercise, we’ll calculate Apple’s total gross profit and gross margin, which combines the profits (and margins) of both the product and service divisions.

From 2019 to 2021, Apple’s gross margin averaged approximately 39%, but from our analysis, the company’s margins have been particularly depressed by the Products division.

In general, the gross profit kept by a technology company like Apple ( AAPL ) tends to be higher for “Services” than “Products”, which can be confirmed by Apple’s historical gross margin for the last three fiscal years.

How To Calculate The Gross Profit Percentage

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Gross Margin Operating Margin EBITDA Margin Adjusted EBITDA Margin FCF Margin NOPAT Margin Operating Cash Flow Margin Pre-Tax Profit Margin Net Profit Margin

Gross margin represents the amount of revenue remaining after subtracting the cost of goods sold (COGS) incurred during the period.

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Because only direct costs are calculated in the metric, gross margin shows how much of the profit remains available to meet fixed costs and other non-operating costs.

Calculating a company’s gross margin involves dividing its gross profit by the corresponding period’s revenue, which are also metrics found in the GAAP-based income statement.

In accordance with GAAP accounting standards, the cost of goods sold (COGS) is matched with the associated revenues during the same time period, which is commonly known as the “matching principle.”

How To Calculate The Gross Profit Percentage

To express the metric in percentage form, the resulting decimal value must be multiplied by 100.

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For example, if a company generated $10 million in revenue with $8 million in COGS, gross profit is $2 million.

After dividing the gross profit of $2 million by the revenue of $10 million, and then multiplying by 100, we arrive at 20% as our gross profit margin.

Since the gross margin ratio represents the percentage of a company’s revenue retained as gross profit, expressed on a per-dollar basis, a 20% gross margin implies that for every dollar of revenue generated, the company retains $0.20, while $0.80 is attributed of incurred cost of goods sold (COGS).

The interpretation of a company’s gross margin as “good” or “bad” depends fundamentally on the industry in which the company operates. For any comparisons to be useful, companies must operate in the same or similar industry with historical data available going back several years to get a better sense of the industry norm (and patterns).

What Is Gross Profit Margin?

As would reasonably be expected, higher gross margins are usually viewed in a positive light, as the potential for higher operating margins and net profit margins increases.

An accurate assessment of the gross profit metric, however, depends on an understanding of industry dynamics and the company’s current business model.

For our example modeling exercise, we will calculate and compare the gross profit margin of three companies, each with different revenue and COGS assumptions.

How To Calculate The Gross Profit Percentage

Next, each company’s gross profit is divided by revenue to arrive at the gross profit margin metric.

Gross Margin Ratio Definition And Formula (2023)

Regardless of the differences in operating expenses (OpEx), interest expense and tax rates between these companies, none of these differences are captured in gross margin.

Gross margin isolates profit only after COGS is taken into account, making the metric more informative for peer comparisons.

Since COGS has already been accounted for, the remaining funds are available to be used to pay operating expenses (OpEx), interest expense and taxes.

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