## Gross Profit Ratio

Also known as the Gross Profit Margin ratio, **it establishes a relationship between gross profit earned and net revenue generated from operations (net sales)**. The gross profit ratio is a profitability ratio expressed as a percentage hence it is multiplied by 100.

Net sales consider both Cash and Credit Sales, on the other hand, gross profit is calculated as Net Sales *minus* COGS. The gross profit ratio **helps to ascertain optimum selling prices** and improve the efficiency of trading activities.

It also helps find out the lowest selling price of goods per unit to an extent that the business will not suffer a loss.

## Formula to Calculate Gross Profit Ratio

Note – It is represented as a percentage so it is multiplied by 100.

**Gross Profit** = Net Sales – **COGS**

**COGS** = Opening Stock + Purchases + Direct Expenses* – **Closing Stock**

*Only used if they are specifically provided

**Net Sales** = Cash Sales + Credit Sales – Sales Returns

## Example

Ques. Calculate the GP ratio from the below information

Sales | 7,00,000 |

Sales Returns |
1,00,000 |

Cost of Goods Sold | 3,00,000 |

Gross Profit Ratio = (Gross Profit/Net Sales)*100

**Net Sales** = Sales – Returns

7,00,000 – 1,00,000

= 6,00,000

**Gross Profit** = Net Sales – COGS

6,00,000 – 3,00,000

= 3,00,000

GP Ratio = (3,00,000/6,00,000)*100

= 50%

This means that for every 1 unit of net sales, the company earns 50% as gross profit. Alternatively, the company has a gross profit margin of 50%, i.e. 0.50 units of gross profit for every 1 unit of revenue generated from operations.

## High and Low Gross Profit Ratio

A business is rarely judged by its Gross Profit ratio, it is only a mild indicator of the overall profitability of the company.

**High** – A high ratio may indicate high net sales with a constant cost of goods sold or it may indicate a reduced COGS with constant net sales.

**Low** – A low ratio may indicate low net sales with a constant cost of goods sold or it may also indicate an increased COGS with stable net sales.

>Read **Net Profit Ratio**