What is the Gross Profit Percentage? Description
The Gross Profit Percentage is a ratio which can be derived from
an income statement. GPP reveals the resulting profit from operations after
all variable costs have been subtracted from revenues. It can be used for
determining the efficiency of the performance of a company, because
it shows the production efficiency in relation to the prices and unit volumes
at which products or services are sold.
How to use the Gross Profit Percentage ratio
Comparing the Gross Profit Percentage provides the most meaningful information. For example:
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Comparing the Gross Profit Percentage ratio with an industry average
(ensure the method used of calculating the industry ratio is the same).
This provides an indication of whether the company is performing better
or worse than the industry as a whole. The comparison is useful for obtaining
a preliminary knowledge of the company's business.
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Comparing the Gross Profit Percentage between different divisions
within an entity. This comparison indicates which divisions may require
further investigation. The comparison is useful for obtaining a detailed
knowledge of the company's business.
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Comparing the Gross Profit Percentage over time. For example:
comparing this year with last year. An increase in the ratio over the previous
year may be an indication that cost of sales is understated (including,
for example, an overstatement of closing inventory) or that revenue is overstated;
a decrease may indicate that cost of sales is overstated or that gross revenue
is understated. (Where monthly figures are available, an examination of
the ratio for the last two months of the financial year could assist in
highlighting any adjustments made to revenue and cost of sales at year end.)
In many instances, however, a change in the ratio is caused by a change
in production methods, product mix, or some other legitimate reason.
Gross Profit Percentage ratio calculation
A common Gross Profit Percentage ratio calculation goes as follows: Add
together the costs of overhead, direct materials and direct labor; subtract
the total from revenue; and then divide the result by revenue. A problem with
this approach is that many of the production costs are not truly variable.
In order to avoid this, you can use another calculation formula, which
only includes direct materials in the formula, shifting the other production
costs into operational and administrative costs. This obviously yields a higher
gross margin percentage.
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Financial Statement Analysis | Ratio Analysis Ratio Analysis, Finanical Statement Analysis
This presentation provides insights in Financial statement and ratio analysis, and includes the following sectios:
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Gross Profit Percentage Diagram Efficiency of the Performance of a Ccompany
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