The Gross Profit Percentage
is a ratio that can be derived from an income statement and reveals the profit left over from operations after all variable costs
have been subtracted from revenues. It can be used for determining
Operating Performance, because it shows the production efficiency in relation to the prices and unit volumes at
which products or services are sold.
the ratio provides the most meaningful information. For example:
ratio to 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 when obtaining a preliminary knowledge of
the company's business.
between different divisions within an entity. This comparison
provides an indication of which divisions may require further
investigation. The comparison is useful when obtaining a detailed
knowledge of the company's business.
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 due to a change in production methods, product mix,
or some other legitimate reason.
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, an alternate calculation formula 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.
Compare with Gross Profit Percentage:
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