Profitability
Ratios:
Consider the following example:

Year 1 ($) 
Year 2 ($) 
Revenue (Revenue) 
100 
150 
Cost of sales 
75 
120 
Gross profit 
25 
30 
Gross profit
to sales (Gross profit margin)
Shows the amount of profit made on each dollar of
sales. Also indicates the percentage of sales that is available to pay for
expenses and to retain as profit.
Gross Profit 
x 100 
Revenue 
Gross profit
margin 

Year 1 
Year 2 




Can also be expressed as

Can also be expressed as
Gross profit
to cost of sales (Mark up) Shows the gross profit as a percentage of cost of
sales. Also indicates how much profit is added to every dollar of the cost of
goods sold.
Note that in year 2, despite that profit has increased
(from $25 in year 1 to $30 in year 2), margin is less (20% compared to 25% in
year 1). Markup also is less (25% as compared to 33.3% in year 1). Possible reasons for these differences are listed in the grid below:
Relationship
between margin and markup: As can be seen above, gross profit margin and markup
are related. This is because they are calculated by the same figures. Remember
that gross profit = Revenue – cost of sales. Therefore, Gross profit margin can be expressed as
and Markup can be expressed as
As such, when one is given, the other can be easily
calculated. Simply apply one of the following rules:
The above rules apply for both fractions and
percentage. Let us try (we use the example given above) Net profit
to sales (Net profit margin) Shows the amount of net profit earned from each dollar
of sales made, after all expenses have been paid.
Like other ratios, net profit margin also may increase
or decrease.
Given net profit = gross profit – expenses, we can
also calculate the Expenses to sales ratio (also known as
expenses to turnover ratio). This shows the amount from each dollar of sales that
is used to pay for expenses.
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