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Gross Profit Ratio (GP Ratio):

Definition of gross profit ratio:

Gross profit ratio (GP ratio) is the ratio of gross profit to net sales expressed as a percentage. It expresses the relationship between gross profit and sales.


The basic components for the calculation of gross profit ratio are gross profit and net sales. Net sales means that sales minus sales returns. Gross profit would be the difference between net sales and cost of goods sold. Cost of goods sold in the case of a trading concern would be equal to opening stock plus purchases, minus closing stock plus all direct expenses relating to purchases. In the case of manufacturing concern, it would be equal to the sum of the cost of raw materials, wages, direct expenses and all manufacturing expenses. In other words, generally the expenses charged to profit and loss account or operating expenses are excluded from the calculation of cost of goods sold.


Following formula is used to calculate gross profit ratios:

[Gross Profit Ratio = (Gross profit / Net sales) 100]


Total sales = $520,000; Sales returns = $ 20,000; Cost of goods sold $400,000

Required: Calculate gross profit ratio.


Gross profit = [(520,000 20,000) 400,000]

 = 100,000

Gross Profit Ratio = (100,000 / 500,000) 100

= 20%


Gross profit ratio may be indicated to what extent the selling prices of goods per unit may be reduced without incurring losses on operations. It reflects efficiency with which a firm produces its products. As the gross profit is found by deducting cost of goods sold from net sales, higher the gross profit better it is. There is no standard GP ratio for evaluation. It may vary from business to business. However, the gross profit earned should be sufficient to recover all operating expenses and to build up reserves after paying all fixed interest  charges and dividends.

Causes/reasons of increase or decrease in gross profit ratio:

It should be observed that an increase in the GP ratio may be due to the following factors.

  1. Increase in the selling price of goods sold without any corresponding increase in the cost of goods sold.
  2. Decrease in cost of goods sold without corresponding decrease in selling price.
  3. Omission of purchase invoices from accounts.
  4. Under valuation of opening stock or overvaluation of closing stock.

On the other hand, the decrease in the gross profit ratio may be due to the following factors.

  1. Decrease in the selling price of goods, without corresponding decrease in the cost of goods sold.
  2. Increase in the cost of goods sold without any increase in selling price.
  3. Unfavorable purchasing or markup policies.
  4. Inability of management to improve sales volume, or omission of sales.
  5. Over valuation of opening stock or under valuation of closing stock

Hence, an analysis of gross profit margin should be carried out in the light of the information relating to purchasing, mark-ups and markdowns, credit and collections as well as merchandising policies.

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You may also be interested in other articles from "financial statement analysis" chapter:

  1. Horizontal and Vertical Analysis
  2. Ratios Analysis
  3. Horizontal Analysis or Trend Analysis
  4. Trend Percentage
  5. Vertical Analysis
  6. Accounting Ratios Definition, Advantages, Classification and Limitations:
  7. Gross profit ratio
  8. Net profit ratio
  9. Operating ratio
  10. Expense ratio
  11. Return on shareholders investment or net worth
  12. Return on equity capital
  13. Return on capital employed (ROCE) Ratio
  14. Dividend yield ratio
  15. Dividend payout ratio
  16. Earnings Per Share (EPS) Ratio
  17. Price earning ratio
  18. Current ratio
  19. Liquid/Acid test/Quick ratio
  20. Inventory/Stock turnover ratio
  21. Debtors/Receivables turnover ratio
  22. Average collection period
  23. Creditors/Payable turnover ratio
  24. Working capital turnover ratio
  25. Fixed assets turnover ratio
  26. Over and under trading
  27. Debt-to-equity ratio
  28. Proprietary or Equity ratio
  29. Ratio of fixed assets to shareholders funds
  30. Ratio of current assets to shareholders funds
  31. Interest coverage ratio
  32. Capital gearing ratio
  33. Over and under capitalization
  34. Financial-Accounting- Ratios Formulas
  35. Limitations of Financial Statement Analysis


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