Gross profit rate shows a firm's ability to pay overhead. The formula for calculating gross profit rate is gross profit divided by sales. The gross profit ratio is useful when comparing between years as it allows managers to see if there are differences from period to period. A reduction in gross profit rate shows the company reduced its gross profit or increased sales without changing the gross profit.
- Skill level:
Determine the firm's gross profit. Gross profit equals sales minus cost of goods sold. These figures are available on the firm's income statement. For example, Firm A has sales of £325,000 and cost of goods sold of £195,000 so their gross profit is £130,000.
Determine sales. This number should not include any discounts given to customers, returns or allowances. In the example, Firm A has £195,000 in sales.
Divide gross profit by sales to determine the gross profit rate. In the example: £130,000 divided by £195,000 equals a gross profit rate of 0.667 or 66.7 per cent.
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