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The gross profit margin helps determine how well a company generates revenue from the cost of producing goods and services. Gross profit margin equals the percentage of revenue that exceeds the cost of goods sold (COGS). The higher the percentage, the more efficient the company generates profit for every dollar of the applicable direct costs.
Key Takeaways
- Gross profit margin is the percentage of revenue that exceeds the cost of goods sold.
- The key costs included in the gross profit margin are direct materials and direct labor.
- Gross profit margin excludes depreciation, amortization, and overhead costs.
- If depreciation is included in COGS by exception, it impacts the gross profit margin.
Calculating Gross Profit Margin
Gross profit is a company’s income after subtracting the costs of producing and selling its products. Gross profit is shown as a whole dollar amount and is calculated by:
Gross Profit = Revenue – Cost of Goods Sold
Gross profit margin is the percentage of profit generated and is calculated by dividing gross profit by revenue as shown below:
Important
Revenue is the total income generated for a period.
Costs Included in Gross Profit Margin
The two components of gross profit and gross profit margin are total revenue and COGS. Revenue sits at the top of a company’s income statement, which is why it’s referred to as the top-line number. COGS is the direct costs a company pays to produce its goods and includes:
- Direct materials
- Direct labor
- Equipment costs involved in the production
- Utilities for the production facility
- Shipping costs
What Is Excluded?
Gross profit only includes the costs directly tied to the production facility, while non-production costs like company overhead for the corporate office are not included. There are exceptions whereby a portion of depreciation could be included in COGS and ultimately impact gross profit margin.
Sometimes the source of the depreciation expense determines whether the expense is allocated as a COGS or an operating expense. If depreciation expenses are included in COGS, they are captured in the gross profit margin.
Below is a portion of Walmart’s (WMT) income statement as of January 31, 2025:
- Total revenue (in red) was $680.98 billion, while the COGS was $511.75 billion (in blue).
- Gross profit margin was 36%, ($680.98 – $511.75 COGS) ÷ 680.98 = 0.25 X 100 = 25%
- Operating expenses and overhead, listed as selling, general, and administrative (SG&A) expenses are listed below COGS and go into calculating operating income, which came in at $29.35 billion for the period (highlighted in blue).
How Can Depreciation Impact Gross Profit and Gross Profit Margin?
If a portion of depreciation on the manufacturer’s plant and equipment is included in overhead costs or fixed costs for the plant and directly tied to producing the goods for the company, the depreciation for those fixed assets might also be included in COGS and be included in gross profit and gross profit margin.
How Do Companies Measure Profitability?
The gross profit margin shows how well a company is performing. However, there are other measures, including operating profit margin and net profit margin. Operating profit margin includes indirect costs such as overhead and operational expenses. Net profit margin is the percentage of profit earned after all expenses are deducted, including taxes, interest payments, and any extra expenses not deducted for gross profit margin or operating profit margin.
How Do Revenue and Net Income Differ?
Revenue is the total monies generated by the sale of goods or services. Income or net income is a company’s total earnings minus expenses.
The Bottom Line
A company’s gross profit margin is the money it makes after subtracting the costs of business and production. The metric is expressed as a percentage of sales and may also be known as the gross margin ratio.
