What does gross profit percentage mean?

Revolut Contributor

 · 06/24/2020  · 06/24/2020

The gross profit percentage of a business is merely another way of describing its gross profit margin. In simple terms, this is the ratio that reveals how much profit a business makes for every pound that it generates in sales before it accounts for indirect costs. These are the day-to-day running costs that relate directly to achieving sales, such as raw materials.

How do you calculate the gross profit percentage?

The gross profit of a business has an absolute monetary value. Still, you can easily convert this into a ratio if you divide that figure by the revenue achieved over the same period. You then multiply the answer by one hundred to turn this basic ratio into a percentage.

Gross profit margin = (Gross profit / Revenue) x100

The gross profit percentage formula shown above is simple if you already have an accurate value for the gross profit of the business. If not, the solution is merely to subtract the direct costs of creating the product or service from the total revenue of the business. We cover gross profit in detail here.

Gross profit = Revenue – Direct Costs

One complication is that people frequently describe the terms of these calculations using different words. For instance, they might refer to revenue as the turnover or the total sales. Either way, this is always the full value of whatever the business sold. On a similar note, it’s not unusual for the direct costs to be called the cost of goods sold (COGS). This point is especially true if the costs of production involve making or selling goods rather than services.

What tips are useful for a gross profit percentage calculation?

The main point is to grasp the principle of direct costs. These are expenses that vary depending on the level of production of the good or service. Most indirect expenses – often called fixed costs or overheads – are readily apparent, such as rent paid for a factory space.

Sometimes, the distinction is less clear. For instance, the wages of the sales team are technically a direct cost, as opposed to those of the administration team, which are indirect. In the real world, it’s often impractical to separate salaries into these two different categories.

What is a good gross profit percentage?

There is no straightforward answer as gross profit margins vary hugely between industries – for instance, dairy farmers have tighter margins than a coffee shop – or even sectors within them. A furniture maker typically has higher direct costs than, say, a fabric-design studio, which is predominantly a consultancy. In general, service providers achieve healthy gross margins despite the challenge of deciding how to categorise wages as a direct cost.

The age or size of a business can both play a significant role here too. A newer business will often have lower direct costs as a proportion of its revenue than a more established rival does, despite its overall economies of scale.

What matters is to understand what the gross profit margin says about your business and how this relates to metrics such as the operating profit margin or net profit margin. It’s better to compare each figure to industry benchmarks for the same sector and to watch how these figures change over time than to worry about meeting one abstract target.

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