What is Gross Profit Margin and what can it tell you?

Gross profit is income less cost of sales, the gross profit margin is simply the gross profit expressed as a percentage of sales.

Gross profit x 100 = Gross profit margin
Sales


Once you have established the gross profit margin what does it tell you? Well it allows you to benchmark your business against similar businesses to see how your gross profit margin compares. If their gross profit margins are higher than yours you need to understand the reasons for that and if possible take the appropriate actions (you need to ensure that you are comparing like for like, for example you may be including costs in your cost of sales which others are including elsewhere in their accounts).
The gross profit margin needs to be monitored each month and any variations understood, some changes can be explained quite simply as variations due to the mix of products in the month (the gross profit margin may well vary from product to product and an increase in the amount of low margin products sold in the month may well impact on the margin).
However any unexplained variances or trends need to be investigated as they could be due to:-
- increase in material costs
- increase in labour costs
- decrease in sales prices
- efficiency problems
- material wastage

Looking at the gross profit margin each month and understanding changes can help identify problems at an early stage and by benchmarking against competitors it can provide important information which could be used in your overall business strategy.