Page 199 - Calculating Agriculture Cover 20191124 STUDENT - A

CH 21] Calculating Agriculture 21-11

The key ratios to consider when judging how profitable a company should be or its
efficiency in terms of its profits are:
 Gross Profit Margin Ratio
 Profit Margin
 Return on Assets
 Return on Capital Employed
 Return on Equity

Gross Profit Margin Ratio. Gross profit margin ratio is a profitability ratio that
measures how much of every dollar of revenues is left over after paying cost of goods sold
(COGS). There are many elements that go into the Gross Profit Margins Ratio, these are
derived from the Income Statement and are calculated using revenue (or total revenue),
gross profit, and net profit.

 Revenue (or Total Revenue): All income derived from the sales of goods or services.
The equation is: Quantity of Goods Sold x Price of Goods; or the summation of all
goods sold.
 Gross profit: What's left after deducting the cost of making and selling the product.
The equation is: Gross Profit = Revenue - Cost of Goods Sold. 21
 Net profit: What's left after subtracting from Gross Profit all other business
operating expenses, such as interest and taxes. The equation is:
Net Profit = Gross Profit – (Operating expenses + taxes)

Gross Profit Margin Ratio is a quick and meaningful way to compare companies as
competitors in an industry. The Gross Profit Margin Ratio is expressed as a decimal value or
as a percentage.
When a business sells its inventory to make a profit, the cost of its inventory is marked
up to generate a profit for the firm. As such the Gross Profit Margin measures how
profitably the firm sells its inventory. The comparison for Gross Profit Margin is to the firm’s
net sales, and net sales are calculated by subtracting Returns & Allowances from the firms
Total Sales, both of which are found on the Income Statement.

Net Sales = Total Sales – Returns & Allowances.

As the Gross Profit is the difference between Net Sales and Cost of Goods it is calculated as:

Gross Profit = Net Sales – Cost of Goods

This equation can be expanded with the previous equation to be written as:

Gross Profit = Total Sales – Returns & Allowances – Cost of Goods Sold.

The Gross Profit Margin Ratio is the relationship of Gross Profit to the Net sales. As an
equation it is written as:
Gross Profit
Gross Profit Margin Ratio = ———————
Net Sales

The Gross Profit Margin Ratio equation can be expressed with all of its elements and
bracketed for clarity which is written as:

(Total Sales – Returns & Allowances) – Cost of Goods
Gross Profit Margin Ratio = ——————————————————————————
Total Sales – Returns & Allowances

Example: Newell’s Feed and Supply spent $250,000 on inventory for the year. The store
sold this inventory for $1,500,000. It had $75,000 of its sales returned by
customers for a refund. Calculate (a) the Gross Profit Margin Ratio and (b) the
Gross Profit Margin Ratio percent.
Solution algorithm:

(Total Sales – Returns & Allowances) – Cost of Goods
(a) Gross Profit Margin Ratio = ———————————————————————————
Total Sales – Returns & Allowances
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