How to Calculate Gross Profit Margin
Analyzing an Income Statement
At its core, the gross profit margin measures a company's manufacturing or production process efficiency. It tells managers, investors, and other stakeholders the percentage of sales revenue remaining after subtracting the company’s cost of goods sold.
Any money left over goes to pay selling, general, and administrative expenses. These expenses include salaries, research and development, and marketing, and they appear further down the income statement. All else equal, the higher the gross profit margin, the better.
An Important Measurement Metric
The gross margin serves as an especially important assessment metric within industries and sectors because it allows for a better apples-to-apples comparison among competitors.
A company that sustains higher gross profit margins than its peers almost always has more efficient processes and more effective overall operations. Those efficiencies could signal that the company is a safer long-term investment, as long as its valuation multiple isn't too high.
You can find the appropriate gross margin range for an industry by reading industry reports from equity research analysts, rating agencies, statistical services, and other financial data providers.
Many brokerage firms also have research tools available. For example, investors who have an account with Charles Schwab, one of the largest brokers in the United States, get access to commentary and analysis from institutions like the Swiss bank Credit Suisse. The firm's customers can download and read industry-specific financial reports which include gross profit margin calculations. Other major brokers offer similar tools.
Calculating Gross Profit Margin
You can calculate a company’s gross profit margin using the following formula:
Using a company’s income statement, find the gross profit total by starting with total sales, and subtracting the line item "Cost of Goods Sold." This gives you the company’s profit after covering all production costs, but before paying any administrative, overhead costs, along with anything else that doesn't directly factor into producing the company’s widgets.
Example of a Fictional Company
Let's say you want to calculate the gross profit margin of a fictional company called Greenwich Golf Supply. You can find its income statement at the bottom of this page. For this exercise, assume the average golf supply company has a gross margin of 30%.
Take the numbers from Greenwich Golf Supply's income statement and plug them into the gross profit margin formula:
- $162,084 gross profit ÷ $405,209 total revenue = 0.40, or 40%
The answer, .40 (or 40%), reveals that Greenwich is much more efficient in the production and distribution of its product than most of its competitors.
Once you know a company has a better gross profit margin, the next question a potential investor, analyst, or competitor would want to ask is, "Why?" What makes Greenwich so much more profitable? Does it have a source of low-cost inputs? If so, is it sustainable?
As an example of how gross profit margins aren't always sustainable, you can watch airline companies. Certain airlines hedge the price of fuel when they expect oil prices to rise, allowing these firms to generate much higher earnings per flight than competitors. The benefit has limits because those hedging contracts expire. Therefore, the profit boost is temporary.
Example With a Real Company
Let's assume that a typical jewelry store generates gross profit margins of between 42% and 47%. With that in mind, how does Tiffany & Co. compare? To find the answer, dig into the company's 2014 income statement.
For the period in question, Tiffany had a gross profit of $2,537,175,000 with sales of $4,249,913,000. Putting this in the gross profit margin formula, you’ll discover that:
- $2,537,175,000 ÷ $4,249,913,000 = 0.597
- 0.597 converted to a percentage becomes 59.7%
According to this analysis, Tiffany appears far more efficient than its competitors. The gross profit margin suggests that Tiffany can convert more of each dollar in sales into a dollar of gross profit. These extra profits give Tiffany opportunities to build the brand, expand, and compete against other firms.
When you dig deeper into the company’s annual financials in its 10-K filing, you find that this is due—at least in part—to its ability to generate much higher sales per square foot than other jewelry stores. While Tiffany generated $3,100 per square foot in 2014, competitor Signet Jewelers (which operates Kay Jewelers, Zales, and Jared) generated less than $2,000 per square foot.
Tracking the Gross Profit Margin
Generally speaking, gross margins remain fairly stable throughout a company's lifetime. Significant fluctuations can be a potential sign of fraud, accounting irregularities, mismanagement, or increases in the cost of raw materials.
If you are analyzing the income statement of a business and find its gross margin has historically averaged around 3% to 4%, but the most recent year saw its margins suddenly shoot up to 25%, it should warrant serious investigation. There may be an entirely legitimate reason for the increase, but you want to know exactly where, how, and why that money is being generated.
Using Tiffany & Co. again, you can see its gross margin stability over a five year period:
- 2010 gross profit margin = 59.1%
- 2011 gross profit margin = 59.0%
- 2012 gross profit margin = 57.0%
- 2013 gross profit margin = 58.1%
- 2014 gross profit margin = 59.7%
|Greenwich Golf Supply Consolidated Statement of Earnings|
Fiscal year ended
Sept 30, 2019
Oct 1, 2018
Cost of Sales
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.
Charles Schwab. "Investment Research." Accessed Feb. 3, 2020.
NASDAQ, Inc. "How Do Airlines Hedge Against Rising Fuel Prices?" Accessed Feb. 3, 2020.
Tiffany & Co. "Annual Report on Form 10-K for the Year Ended January 31, 2015," Page 6. Accessed Feb. 3, 2020.
Signet Jewelers Limited. "2014 Annual Report," Pages 14, 27. Accessed Feb. 3, 2020.
Tiffany & Co. "Annual Report on Form 10-K for the Year Ended January 31, 2015," Page 45. Accessed Feb. 3, 2020.
Tiffany & Co. "Annual Report on Form 10-K for the Year Ended January 31, 2014," Page 41. Accessed Feb. 3, 2020.
Tiffany & Co. "Annual Report on Form 10-K for the Year Ended January 31, 2013," Page 40. Accessed Feb. 3, 2020.
Tiffany & Co. "Year-End Report 2011," Page 38. Accessed Feb. 3, 2020.
Tiffany & Co. "Year-End Report 2010," Page 38. Accessed Feb. 3, 2020.