A lot of people will confuse Gross Profit Margin with the term Gross Profit, but one is expressed as a percentage (that’s the margin) while the Gross Profit is simply a dollar amount. Why is that different? Because we express things as a percentage so that they can be compared to different months or years within the same company, or to compare one company to another company that are likely different sizes.
So what is Gross Profit and Gross Profit Margin, and how do you calculate it? Gross Profit is simply revenues from the sales of products or services, less your cost of goods sold or cost of sales (which it’s sometimes called). Traditionally, it was called cost of goods sold, especially when most businesses were in some sort of manufacturing or distribution business. Cost of sales was nothing more than your cost of the product that you were selling, how much you bought it for, how much it cost you to get it and then then to ship it. You excluded shipping costs many times from different industries. The calculation of cost of goods sold is very much determined by the industry that you’re in. These days in technical or technology businesses or service businesses, cost of goods sold will many times include the costs of direct labor, the cost of the technology that your customers are interfacing with, the cost of a very specific direct advertising charge such as a click type advertising that directly led to a sale. The calculation of cost of goods sold does need to be determined by the industry that you’re in, but it’s a fairly simple calculation to get net profit.
A Gross Profit Margin uses that to number determine your efficiency over time by comparing yourself to prior months or years. Or you can come compare yourself to other companies in your industry that are similar to you, and if your Gross Profit Margin is higher, then you are more efficient, perhaps a better producer a better seller than that other company is, though there could be other factors for that.
We’re going to continue to focus on profitability measures in the coming weeks before we deep dive into some other measurements and ratios, so stay tuned. If we can be of any service to you in the new year, don’t hesitate to reach out!