Gross Margin Ratio

The gross margin ratio measures a product's profitability

The gross margin ratio examines the relationship between sales and cost of goods sold by seeing the the gross profit as a percentage.

By finding the gross margin (net sales - cost of goods sold), a company can figure out how much money they retain after accounting for all the expenditures associated in making the product.

It essentially finds the amount of money that can go to net income for every dollar made in revenue by products sold. For example: if the ratio is 0.5, that means 50 cents of every dollar made goes towards paying for expenses and 50 cents goes to profit.

The higher the gross margin ratio, the more profitable the product is, which means more money going to paying off debts and liabilities, and more profit overall. The inverse is also true, the lower the gross margin, the less profitable a company's product is.

By comparing the gross margin ratio with competitors, the company can see how profitable they are in comparison to the industry standard and whether they need to make any adjustments to their processes (such as decreasing labor costs or materials costs, improving manufacturing processes, etc.). By putting it into a percentage, it becomes very easy to make these comparisons.

Examples

In 2017, Apple Inc. had a gross margin of $88,186 million, and net sales worth $229,234 million. Find the gross margin ratio.

$88,186 /$229,234 = 0.3847

Exotic Case has the following information available in its internal reporting system:

• Sales volume, in units: 47,350

• Selling price per unit: $300

• Cost of goods sold per unit: $140

• Fixed costs: $3,500,000

What is the gross margin ratio?

47350*300 = 14,205,000 (Net sales)

47350*140 = 6,629,000 (cost of goods sold)

14,205,000-6,629,000 = 7,576,000 (gross margin)

7,576,000/14,205,000 = 0.5333 (gross margin)

Sources

https://www.investopedia.com/terms/g/grossmargin.asp

https://www.educba.com/gross-margin-formula/