Gross Profit Margin Calculator

What this calculator does

Of every unit of revenue a business takes in, some was spent simply acquiring or producing the thing that was sold. What survives that is gross profit, and expressed as a percentage of sales it is the gross profit margin. This calculator returns both:

Gross profit = Sales − Cost of goods sold

Gross profit margin = Gross profit ÷ Sales × 100

It is the first profitability measure on the income statement and the narrowest in scope, which is exactly what makes it useful. It describes the economics of what the company sells, before anything about how the company is run gets mixed in.

The first cut, before the company itself gets paid for

An income statement takes several bites out of revenue, one after another, and gross margin is the first. Only the direct costs of the goods or services sold come out at this stage: the materials, the manufacturing labour, the wholesale price of stock a retailer bought to resell.

Everything else is still to come. Salaries for people who do not make the product, rent on the head office, marketing, research, interest on borrowings, and tax all get deducted further down. So the gross margin is measuring something quite specific: the gap between what customers pay and what it costs to give them the thing they paid for.

That makes it a read on two forces. One is pricing power, or how much more than cost the market will let you charge, which is mostly about brand, differentiation and competition. The other is production efficiency, or how cheaply you can make or source it. A margin that falls over time is telling you that one of those has weakened, and it is usually worth finding out which before looking at anything further down the statement.

Two figures, and the judgement hiding inside cost of goods sold

1. Sales. Total revenue for the period, ideally net of returns and discounts.
2. Cost of goods sold. The direct cost of what was sold in that same period.

The first figure is straightforward. The second contains more judgement than its plain name suggests, and this is the main hazard when comparing one company against another.

There is no universal rule about where the line falls. Some companies put warehousing and delivery inside cost of goods sold; others treat them as operating expenses further down. Some include depreciation on factory equipment; others do not. Companies selling services may report no cost of goods sold at all, or may include the salaries of staff delivering the work. Two competitors can therefore report visibly different gross margins while running very similar economics, purely because of where each drew the boundary.

Two habits deal with this. When comparing companies, read the accounting policy note describing what each includes before trusting a difference of a few points. When tracking one company over time, the definition is usually consistent, so the trend is far more reliable than the level.

Four businesses, four very different margins

Take four companies, each with sales of 2,000,000, and vary only the direct cost of what they sold.

• Software company, cost of goods sold 300,000: margin 85.00 percent. Another copy costs almost nothing to deliver.
• Retailer, cost of goods sold 1,300,000: gross profit 700,000, margin 35.00 percent.
• Commodity distributor, cost of goods sold 1,800,000: margin 10.00 percent. Buying and reselling with little room in between.
• A company selling below cost, cost of goods sold 2,200,000: margin −10.00 percent.

That last case deserves a moment. A negative gross margin means the business loses money on every sale before paying a single overhead, so selling more makes things worse rather than better. It happens, in price wars, in businesses buying market share deliberately, and in companies whose costs have risen faster than they can raise prices. Whatever the cause, it is the one margin reading that cannot be fixed by cutting overheads.

Gross margin sets the ceiling for every margin below it

Here is the structural fact that makes this the most informative single margin on the income statement. Because gross profit is what remains before all the other costs, and every later deduction only takes more away, no margin further down can ever be larger. Gross margin is a hard ceiling.

A company with a 35 percent gross margin has 35 percent of revenue with which to pay for absolutely everything else: its offices, its salespeople, its research, its interest, its tax, and whatever is meant to be left over for shareholders. Its operating margin will be lower, its net margin lower still. A company with an 85 percent gross margin can spend heavily on research and marketing and still finish with a healthy net margin, because it started with so much more room.

This is why gross margin tells you more about what kind of business you are looking at than almost any other figure, and why comparing it against the operating and net margins beneath it is so revealing. A wide gross margin with a thin net margin says the product economics are excellent but the company is expensive to run, which is a fixable problem. A thin gross margin with a respectable net margin says the operation is being run with real discipline, but there is very little cushion if input costs rise. And a thin gross margin that keeps thinning is the earliest warning an income statement gives, because it appears at the top and everything below inherits it.

Questions people ask

What is a good gross profit margin?

Entirely industry-dependent. Software and pharmaceuticals routinely run above 70 percent, groceries and commodity distribution in single digits. Compare against similar businesses and against the company's own trend.

How does this differ from net profit margin?

Gross margin deducts only the direct cost of what was sold. Net margin deducts everything, including overheads, interest and tax. Gross margin is always the larger of the two.

What goes into cost of goods sold?

Direct costs of producing or buying what was sold: materials, production labour, and the purchase cost of goods for resale. Where companies place items such as delivery and factory depreciation varies, so read the policy note before comparing.

Can gross margin be negative?

Yes, when it costs more to make or buy the product than customers pay for it. It is a serious signal, because increasing sales volume then increases the loss.

References

Profitability ratios measure how effectively an organisation earns a profit, with margin measures showing how much of each unit of sales revenue is returned as profit; the larger the ratio, the more of each sales unit is retained. Gross profit margin is the first of these measures, deducting only the cost of goods sold, so it precedes and constrains the operating and net margins reported further down the income statement.

1. OpenStax, Principles of Finance, 6.6 Profitability Ratios and the DuPont Method. https://openstax.org/books/principles-finance/pages/6-6-profitability-ratios-and-the-dupont-method
2. OpenStax, Principles of Accounting, Volume 1: Financial Accounting, Appendix A: Financial Statement Analysis. https://openstax.org/books/principles-financial-accounting/pages/a-financial-statement-analysis