Profitability Ratio:Gross Profit Margin

June 8th, 2006 Comments off
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Continued from my last article, we now look at the financial ratio for assessing the profitability of a company.

This type of financial ratio should be able to measure the bottom-line results or the profitability of the company.

One typical major Profitability ratio is:

The GROSS PROFIT MARGIN

FORMULA

Gross Profit / Net Sales

MEASURE WHAT

Profitability of trading and mark-up

SCORE OR VALUE

Varies.

15-25% for supermarkets

#90 % for software industry

20-30% is OK

SALIENT POINTS TO NOTE:

1.Must be compared to industry averages and the  trend over time

2.  High gross margin means a lot of money left over to spend on other business operations such as research & development or marketing.

3. If GPM is on downwards trends, might be a tell tale sign of future problems facing the bottom line [when labor and material costs increase rapidly, likely to lower gross profit margins-unless company pass these costs to customers in the form of higher selling prices

4. The results may skew if the company has a very large range of products

5. An increase in this ratio might indicate the following:

· Increase in selling price without corresponding increase in cost,

· Decrease in costs not reflected in the selling price or a decrease in selling price with the same amount of gross profit,

· Opening stock valued at a smaller figure,

· Invoices for purchases being omitted,

· Consignment stocks being recognize as sales,

· Sales being over-recognize despite work has not been done,

· Closing stock valued too high

6.   A decrease in this ratio might indicate the following:

· Decrease in selling price without corresponding decrease in cost,

· Increase in costs without a corresponding increase in the selling price,

· Closing stock being undervalued,

· Omission of closing stock

· Third party goods including proprietors including in the purchases account,

· Stocks being misappropriated.

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Financial Accounting

 
 

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