The accounting ratios are grouped into three main categories such as the profitability
ratios. In this video we will specifically look at the gross profit margin ratio!
I’m Thomas Harwood and Welcome to The Accounting Student, where we create free and short videos
so that you can learn about accounting.
Today’s video is looking at the gross profit margin ratio.
As mentioned in the previous video on "The Accounting Ratios", that the financial statements
such as the income statement and the balance sheet would be very unhelpful to all but the
highly skilled professionals, without the use of accounting ratios.
The accounting ratios play an important role in fulfilling the needs of the users of the
financial statements, and therefore the statements can be easily interpreted and be of beneficial
use.
Accounting ratios are used to analyse or compare financial data and will allow the user to
gain an insight into how a business is performing from one period to another or how a business
is performing against another business.
The accounting ratios can be categorised into three main groups and they are profitability,
liquidity and efficiency.
Profitability ratios look at the profits and returns of the business. This is normally
shown as a percentage of the revenue of the business.
The profitability ratios can be split further into more ratios which the gross profit margin
ratio is one of the most common of this group.
The gross profit margin ratio looks at the relationship between the gross profit and
sales. Typically, a business will look to achieve a high gross profit margin in general
as an overall business and also on the products or services that they provide.
The method used to calculate gross profit margin is the gross profit divide by the sales
value and then the result is then multiplied by one hundred to get the value as a percentage.
Let’s have a look at an example.
Tim owns a top shop and his main product sold during the year was a rocket ship. He recently
sold one of the rockets at a sales price of £300 and the gross profit for this rocket
was £60. Tim wants to know the gross profit margin for this rocket.
So, if you follow the formula for the ratio and add the information provided by Tim, you
can calculate the gross profit margin.
Therefore, we will get the gross profit of £60 and divide this by the sales value of
£300. We then get 1/5 or 0.2 and multiply this by 100 which gives us 20%.
Consequently, for this rocket, Tim made a gross profit margin of 20%, which is really
good!
We should also be aware that the gross profit margin can increase due to a few factors.
One is if the selling price for the product or service increases whilst the cost to make
or provide the product or service remains the same.
Also, if a company manages to lower the cost of producing the product or service due to
purchasing the stock or materials at lower prices may also be a factor in increasing
the gross profit margin ratio.
Additionally, different sectors and industries operate differently from one to another so
therefore the gross profit margins will differ too. For example, food supermarkets will have
small profit margins but aim to turnover their stock quickly. Whereas on the other hand,
car dealerships tend to take a long time to sell a car, but the profit margin is very
high, especially more with sports and high end cars!
So that was the explanation of the gross profit margin ratio. If you enjoyed it, press the
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