Chapter 12
Using Accounting Information
368
Gross Profit Margin
The gross profit margin is used to demonstrate the impact of cost of goods sold on the income
statement. In other words, the gross profit margin subtracts cost of goods sold from sales revenue,
the result of which is divided by sales revenue.The formula is shown below.
=
Gross Profit*
Gross Profit Margin
Sales Revenue
*Gross Profit = Sales Revenue – Cost of Goods Sold
Gross profit margin
reveals the percentage of revenues left after costs which are directly involved
in producing the goods or services of the business are deducted. That is, the amount of profits
remaining after deducting the cost of goods sold. The remainder is used to pay for operating and
other expenses. Figure 12.17 calculates the gross profit margin using figures from Second Cup’s
income statement for 2013 and 2014.
2014
2013
Gross Profit
$20,493
$23,134
Total Revenue
$28,172
$27,188
Gross Profit Margin
73%
85%
_______________
Figure 12.17
A higher gross profit margin means that the company has an easier time covering its expenses and
is more likely to be profitable. However, gross profit margins should be compared to an industry
average to determine whether they are healthy or not. Also, a decline in the gross profit margin,
such as with Second Cup, indicates that the company is either not generating enough revenue, has
experienced an increase in inventory costs or both.
Net Profit Margin
The
net profit margin
assesses a company’s profitability after all expenses have been deducted.This
is the amount of net profit or loss per dollar of revenue.The formula is shown below.
=
Net Income
Net Profit Margin
Sales Revenue
As with the gross profit margin, a higher net profit margin is generally considered a better sign
than a lower one, although it should be always be compared to an industry average and previous
