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Gross Profit Ratio - Profitability Ratio

VSAT 2023

What is the Gross Profit Ratio?

Last updated date: 25th Jan 2023
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The gross profit ratio refers to the relationship between the revenue from operations with the gross profit earned by an enterprise. The difference between the sales of an enterprise and the cost of goods sold results in the company's gross profit ratio. The gross profit ratio is an example of a profitability ratio. This article will discuss the gross profit ratio, the gross profit ratio formula, the objectives and significance of the gross profit ratio, and examples and methods to compute it.


Reason for Increase or Decrease in Gross Profit

The various reasons for the increase and decrease in gross profit are mentioned here as under

  • The selling price remains constant, and the cost of revenue changes.

  • The cost of revenue remains constant, and the selling price changes.

  • Where both costs of revenue and selling price change.

So the above reasons are responsible for the changes in gross profit due to the organisation's profitability changes.


Objectives and Significance of Gross Profit

To determine the efficiency of the business through profitability ratios, the gross profit ratio is used. Through the various operations of purchase, production and selling operations, the gross profit ratio is used. It should be adequate to cover all expenses to generate dividends and build reserves.


Methods for Computation of Gross Profit Ratio

Computation of gross profit ratio and cost and sales are done in different ways for different types of organisations. The gross profit ratio in such a case is computed as a percentage. The revenue from operation in the case of non-finance enterprises is sales minus sales return, whereas, in the case of financial companies, it is interest earned and dividends received through various other means of income.


Gross Profit ratio = Gross profit/Revenue from operations * 100


Where


Gross Profit = Revenue from Operations - Cost of Revenue from Operations

Revenue from operations (Cost of Goods sold)=

Operating Inventory(excluding Spare Parts and Loose Tools)+ Net Purchases +Direct Expenses- Closing Inventories (excluding Spare Parts and Loose Tools)

Or

Cost of Material Consumed + Purchase of stock in Trade+Change in Inventories of finished goods, Work in Progress and stock in Trade +Direct Expenses

Or

Revenue from Operations- Gross Profit



Solved Gross Profit Ratio Example

Question1: From the following information, calculate the Gross Profit Ratio.


Details 

31st March 2021

31st March 2022

Revenue of operations

16000

20000

Gross Profit

4000

6000


Solution:

Gross Profit ratio = Gross profit/Revenue from operations * 100

For 31st March 2021: 

Gross profit ratio= 4000/16000 *100 =25%

For 31st March 2022: 

Gross profit ratio= 6000/20000 *100 =30%


Question 2: From the following information, calculate the Gross Profit Ratio.

Revenue From operations: 60000

Gross Profit = 25% on cost

Solution:

Let the Cost be Rs. 100

Gross Profit= Rs 25

Sales=Rs 125

Cost of goods sold=100/125*60000=48000

Gross Profit Ratio = Sales-Cost of goods sold=60000-48000=12000

Gross Profit ratio= Gross profit/Revenue from operations * 100

12000/60000*100=20%


Solved Numerical Problems

1. Calculate Gross Profit Ratio from the following information.


Details

Amount

Sales 

850000

Purchase

430000

Opening Inventory

130000

Closing Inventory 

90000

Carriage Inwards

22000


Ans:

Trading Account

  • Dr

  • Cr


Particulars

Amount

Particulars 

Amount

To Opening Inventory

130000

By Sales 

850000

To Purchase

430000

By Closing Inventory 

90000

To Carriage Inwards

22000



To Gross Profit

358000




940000


940000


Gross Profit Ratio= Gross Profit/Revenue from Operations * 100

=358000/850000*100=42.12%


2. From the following information, calculate the Gross Profit Ratio.

Revenue From operations:60000

Gross Profit =25% on cost

Ans:  The computation is here as under

Let the Cost be Rs. 100

Gross Profit= Rs 25

Sales=Rs 125

Cost of goods sold=100/125*60000=48000

Gross Profit Ratio = Sales-Cost of goods sold=60000-48000=12000

Gross Profit ratio= Gross profit/Revenue from operations * 100

12000/60000*100=20%

So the gross profit ratio, in this case, is 20%


Summary

Gross profit is the difference between net sales minus cost of goods sold. The ratio may be compared with the industries of similar segments or may be compared with the same firm with different years. Higher gross profit is desired as it leaves higher profitability and vice versa. It also depicts the relationship between revenue from operations and gross profit.

FAQs on Gross Profit Ratio - Profitability Ratio

1. The gross profit ratio of the company is 30%. State which of the following transactions will 

  1. Increase

  2. Decrease

  3. No change 

Case 1: Purchase of stock in trade Rs 50000

Case 2: Purchase return Rs 1500

Case 1: Purchase of stock in trade Rs 50000

Since both purchases and closing inventory would increase by the same amount so the gross profit will remain unchanged.


Case 2: Purchase return Rs 1500

Since both purchases and closing inventory would decrease by the same amount, the gross profit will remain unchanged.

2. What are the advantages of Gross Profit Ratio?

The advantages of gross profit ratio are as follows:

1. Ease in Inventory Valuation

It allows the accountants to determine the correct inventory value without the performance of stock count.


2. Easy to Compute 

It is very easy to compute as compared to other ratios. There is just a need for a trading account with gross profit and the sales value.


3. Useful in Analysing the Trend

Trend analysis of Gross Profit helps in intra and inter firm comparisons leading to better analysis of data.

3. What are the differences between Gross Profit Ratio and Net Profit Ratio?

The difference between Gross Profit Ratio and Net Profit Ratio are tabulated below.


S No

Basis

Gross Profit Ratio

Net Profit Ratio

1.

Definition 

Gross profit is arrived after deduction of all operating expenses

Net profit is derived after deduction of all expenses whether operating or non operating  

2.

Presentation in financial statements

Gross profit is reflected in the Trading Account in the financial statements.

Net profit is reflected in Profit and Loss Account in the financial statements.

3.

Formula

Gross profit is obtained after deducting Sales and Cost of goods sold

Net Profit is obtained after deducting Gross profit from the indirect expenses.

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