Definition and Explanation:
Gross profit ratio is the ratio
of gross profit to net sales i.e. sales less sales returns. The ratio thus
reflects the margin of profit that a concern is able to earn on its trading and
manufacturing activity. It is the most commonly calculated ratio. It is employed
for inter-firm and inter-firm comparison of trading results.
Formula:
Following formula is used to calculated
gross profit ratio (GP Ratio):
Gross profit / (Net sales ×
100)
Where Gross profit = Net sales -
Cost of goods sold
Cost of goods sold = Opening
stock + Net purchases + Direct expenses - Closing stock
Net sales = Sales - Returns
inwards
Gross profit is what is revealed by the trading
account. It results from the difference between net sales and cost of goods sold
without taking into account expenses generally charged to the profit and loss
account. The larger the gap, the greater is the scope for absorbing various
expenses on administration, maintenance, arranging finance, selling and
distribution and yet leaving net profit for the proprietors or shareholders.
In case, there is increase in the percentage of
gross profit as compared to the previous year, it is indicator of one or more of
the following factors.
- The selling price of the goods has gone up
without corresponding increase in the cost of goods sold.
- The cost of goods sold has gone down
without corresponding decrease in the selling price of the goods.
- Purchases might have been omitted or sales
figures might have been inflated.
- The valuation of the opening stock is
lower than what it should be or the valuation of the closing stock is higher
than what it should be.
- In case, there a decrease in the rate of
gross profit, it may be due to one or more of the following reasons.
- There may be decrease in the selling rate
of the goods sold without corresponding decrease in the cost of goods sold.
- There may be increase in the cost of goods
sold without corresponding increase in the selling price of the goods sold.
- There may be omission of sales.
- Stock at the end may have been
under-valued or opening stock may have been over-valued.
Example:
Calculate gross profit ratio (GP Ratio) from the following
particulars.
particulars |
$ |
particulars |
$ |
Sales |
1,55,000 |
Purchases |
80,000 |
Sales returns |
5,000 |
Purchases returns |
10,000 |
Opening stock |
40,000 |
Closing stock |
10,000 |
Solution:
Cost of goods sold = Opening
stock + Net purchases - Closing stock
= 40,000 + 70,000 - 10,000
= 1,00,000
Net sales = 1,55,000 - 5,000
= 150,000
Gross profit = 1,50,000 -
1,00,000
= 50,000
Gross profit ratio = (50,000 /
1,50,000) x 100
= 33.33 % |