The gross profit ratio is calculated by dividing a firm’s gross profit figure by its net sales (revenue minus the cost of goods sold). The equation is a standard financial metric used to assess a company’s financial health and stability.
A firm’s gross profit ratio reveals the proportion of funds remaining from revenues after accounting for the cost of goods sold. It is a standard calculation to evaluate a firm’s operational performance and an essential source for cost-benefit analysis. The primary components of the gross profit ratio equation are net sales and gross profit. Net sales are equal to total gross sales minus revenue, and gross profit refers to net sales minus the cost of goods sold.
The gross profit margin is not a precise calculation for determining a firm’s pricing strategy. However, the equation is regarded as a sound indicator to evaluate a firm’s financial health. Without determining its gross profit margin, a company would not be able to satisfy its operating expenses and other debts to adequately build for the future
A firm’s gross profit margin should remain stable throughout a given fiscal year. The figure should have limited variance from quarter to quarter unless the firm is positioned in an industry undergoing drastic price fluctuations.