How to Calculate Gross Profit Margin: Definition & Formula

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  • 0:00 What Is Gross Profit Margin?
  • 1:04 What Is Revenue?
  • 1:23 What Are Costs of Goods Sold?
  • 1:57 Calculating Gross…
  • 2:58 Lesson Summary
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Lesson Transcript
Instructor: Tammy Galloway

Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.

In this lesson, you'll learn the purpose of calculating gross profit margin and explore its components. You'll also learn how to analyze the results of the calculation.

What Is Gross Profit Margin?

Galley's Sample Shop is a home décor and furniture store. They would like to expand and open another location, but need a loan to finance the expansion. The CEO submits an application to the bank for a loan. Included in the application are Galley's financial statements.

After reviewing the application, the bank denies the application due to the company's gross profit margin. So, what exactly is gross profit margin and what does it have to do with loaning money? Well, gross profit margin is calculated by subtracting the cost of goods sold from the revenue total and dividing it by the revenue total. The result tells you how much of every dollar is left over to pay operating expenses. Right now, Galley's Sample Shops has only $.20 of every dollar left over to pay operating expenses, which means if sales decreased or suppliers increased their costs, their gross profit margin would be dangerously low. Now that we have a basic understanding of gross profit margin, let's look closer at revenue and costs of goods sold.

What Is Revenue?

Revenue, also called sales, refers to the income received from selling goods or services. Revenue can be found on an income statement and may be separated into cash sales and credit sales. For the purpose of calculating gross profit margin, you will need to add cash sales and credit sales together to get the total revenue.

What Are Costs of Goods Sold?

Cost of goods sold are the expenses a business incurs to purchase or produce goods for sale. For example, a furniture manufacturer would need to purchase wood, glue, nails, stain, paint, and upholstery to make its products. The costs of these materials would be their cost of goods sold.

Galley's Sample Shop, on the other hand, does not make furniture; they simply purchase it from a furniture manufacturer. In this instance, their cost of goods sold would be the expense they incurred to purchase the furniture. Cost of goods sold also can be found on the income statement.

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