A:

The gross profit margin is a baseline profitability ratio measurement against total sales revenue. The gross profit margin is primarily used by companies to examine fixed production and distribution costs, and secondarily to guide company decisions on variable costs to maximize real net profits.

The gross profit margin is the percentage of total sales revenue that remains after deducting direct production-related costs. The formula for calculating gross profit margin is simple:

Total sales revenue - production costs / total sales revenue

The resulting number is then expressed as a percentage. Direct production-related costs include costs of labor and parts used specifically in the process of manufacturing or producing the company's products for sale. These are commonly designated as fixed costs, since most manufacturing companies have long-term contracts for buying necessary parts at fixed prices. Although there is some variation over time, overall, a company's direct manufacturing costs are not expected to experience wide fluctuations from year to year.

Once a company knows its gross profit margin, it also knows how much money remains to cover variable costs of overhead and other operating expenses, taxes and interest due on financing. From the gross profit margin percentage, companies run analyses to help them maximize profitability. Companies use the gross profit figure to examine questions such as the following:

• Does the gross profit margin provide sufficient funds to cover all the other costs of doing business, while leaving an acceptable level of net profits?
• Can the company afford to take on additional debt financing?
• Does the sales price need to be increased to ensure adequate profitability?
• Are current fixed manufacturing costs too high to provide adequate gross profits?

The gross profit margin is the initial profitability calculation done by companies, followed by calculations of operating profit margin and net profit margin; the final calculation showing the percentage of sales revenues the company retains after accounting for its total costs of doing business.

RELATED FAQS
1. What is the difference between gross margin and profit margin?

Understand the difference between gross margin and profit margin, and learn about the profitability ratios used in evaluating ... Read Answer >>
2. What is the difference between gross margin and gross profit?

Understand the difference in definitions between gross margin and gross profit, and learn what each represents as a metric ... Read Answer >>
3. What costs are not counted in gross profit margin?

Explore the various measures of a company's profitability, such as gross, operating and net profit margins, and understand ... Read Answer >>
4. What is the difference between revenue and cost in gross margin?

Discover the differences between revenue and cost in gross margin, along with an explanation of various measures of profitability. Read Answer >>
5. What are the main reasons for why there could be a negative gross profit margin and ...

Find out how to calculate a company's gross profit margin, why a firm might experience a negative margin and how to interpret ... Read Answer >>
6. What are the differences between gross profit and gross margin?

Learn how gross profit and gross margin are calculated and how each is used in fundamental analysis. Generally, these numbers ... Read Answer >>
Related Articles
1. Investing

The Difference Between Gross and Net Profit Margin

To calculate gross profit margin, subtract the cost of goods sold from a company’s revenue; then divide by revenue.
2. Investing

Gross, Operating and Net Profit Margins

A company’s income statement includes the company’s gross, operating and net profits.

How Gross Margin Can Make or Break Your Startup

Find out how your startup's gross margin can impact your business, including why a mediocre margin may spell disaster for a budding business.
4. Managing Wealth

What's a Good Profit Margin for a Mature Business?

How to determine if the amount you clear dovetails with the competition.
5. Investing

Calculating Economic Profit

Economic profit is the difference between the revenue a firm earns from sales and the firm’s total opportunity costs.
6. Investing

Analyzing Operating Margins

Learn how to analyze operating margins and how to put this aspect of equity analysis to work.
7. Investing

Is Net Income The Same As Profit?

Net income and profit both deal with positive cash flow, but there are important differences between the two concepts.
8. Investing

4 Tips to Evaluate Growth Companies (KO, AAPL)

Discover the best metrics for stock investors to utilize when selecting and evaluating the best opportunities in growth investing.
RELATED TERMS
1. Gross Margin

A company's total sales revenue minus its cost of goods sold, ...
2. Profit

A financial benefit that is realized when the amount of revenue ...
3. Contribution Margin

A cost accounting concept that allows a company to determine ...
4. Profitability Ratios

A class of financial metrics that are used to assess a business's ...
5. Operating Margin

A ratio used to measure a company's pricing strategy and operating ...
6. Pretax Profit Margin

A company's earnings before tax as a percentage of total sales ...
Hot Definitions
1. Perfect Competition

Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
2. Compound Interest

Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
3. Income Statement

A financial statement that measures a company's financial performance over a specific accounting period. Financial performance ...
4. Leverage Ratio

A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt, or ...
5. Annuity

An annuity is a financial product that pays out a fixed stream of payments to an individual, primarily used as an income ...
6. Restricted Stock Unit - RSU

A restricted stock unit is a compensation issued by an employer to an employee in the form of company stock.