Calculating Gross Profit Margins
The gross profit margin calculation is a number used in all business accounts and entered into the profit and loss account.
It is sometimes called the gross margin and entered as an absolute number or a percentage, so the % value is the gross profit percentage.
How To Calculate Gross Profit
Calculating gross profit is a simple calculation in its rawest form and is:
- Sales/ turnover/ takings, less:
- Direct cost of sales
Gross Profit Calculation Example
You have sales of £1,000, with direct cost of sale at £250. Your gross profit is £1,000 less £250 which equals £750.
All sales values get recorded net of VAT and discounts provided.
The profit and loss account records sales made during the period of the statement whether or not you have received payment for the sales made. VAT cash accounting is slightly different in that your VAT returns base numbers on cash received into your bank account.
Cost of Sales Explained
The cost of sales are those expenses directly related to the actual sale made. Sometimes the terminology calls these cost of goods sold. These costs usually include:
- The purchase price of the raw materials including any discounts.
- All the wages of production employees.
- Transportation costs incurred to bring the products to your business premises.
- Any other direct costs associated with manufacturing the final product.
In accounting terms, the raw products may include changes in stocks received at your premises. Different businesses use various formulae depending on their industry and requirements. The most common methods are FIFO (First In First Out) or LIFO (Last In First Out) to calculate inventories of materials.
Calculating the Gross Profit Percentage
Rather like the calculation above calculating the percentage is the ratio of the gross profit number divided by the sales figure expressed as a percentage.
Example: taking the values outlined above, your gross profit percentage would be £750 profit divided by £1,000 sales giving 0.75 expressed as a percentage is 75%.
Other Gross Profit Expressions
You can also express gross profit as gross margin or operating margin as they are the same thing.
Industry Average Gross Profits
The gross or operating margin varies widely by industry sector so only compare your business with another related business. Here are a few averages for the sectors shown:
- Airlines 17.02%
- Water companies 30.10%
- Software 22.09%
- Restaurants 15.21%
- Hotels 18.74%
- Retailers 4.74%
Source: Leonard N. Stern School of Business