Updated on May 10, 2022
A company’s ability to recoup the expenses of producing its goods and services can be gauged using the gross profit margin. In business, gross profit margin refers to the amount of revenue generated compared to the cost of goods supplied. Gross profit margin (COGS). If the ratio is greater than one, then the company’s managers are more effective in turning a profit on each dollar of direct costs.
IMPORTANT LESSONS TO LEARN
When sales income surpasses the cost of items sold, a company has a positive gross profit margin (GPM) (COGS).
Direct materials and direct labour make up the bulk of the gross profit margin.
Depreciation, amortisation, and overhead expenditures are not included in the gross profit margin.
COGS may include a component of depreciation, which may affect gross profit margin in some cases.
We must first examine how gross profit is calculated in order to identify what isn’t included in the margin. A company’s gross profit is the amount of money it makes after deducting the costs of making and selling its products. As a complete dollar figure, gross profit is shown.
Gross profit is calculated as the difference between the revenue and the cost of the goods sold.
The gross profit margin is the ratio between revenue and manufacturing expenses at which a business makes a profit. The formula for calculating gross profit margin is as follows:
What Is Included in Gross Profit Margin?
Total revenue and cost of goods sold are the two factors that go into gross profit and, eventually, gross profit margin (COGS). A company’s revenue is the entire amount of money it makes in a certain time period.
The term net sales refers to revenue that includes discounts and deductions due to returned products. The top line number for a corporation refers to the revenue found at the top of the income statement.
Cogs is the total number of direct costs and direct labour costs required to make a product.
The following are some COGS costs:
Materials that can be directly accessed
Equipment and labour expenditures that are directly related to the production process
Equipment and services required by the manufacturing plant
Costs of transportation
What Is Not Included in Gross Profit Margin?
Non-production expenditures, such as corporate overhead, are not included in gross profit because they are not directly related to the manufacturing facility.. The sample below explains gross profit margin and what’s included and what’s excluded.
The income statement for JC Penney Company Inc. (JCP) as of May 5, 2018 is shown below.
Total revenue was $2.67 billion, while COGS totaled $1.7 billion in green (in red).
$1.7 COGS / $2.67 = 0.36 X 100 = 36% gross profit margin. ($2.67-$1.7)
SG&A (selling, general, and administrative) expenses and overhead, which are given below COGS, are used to calculate operating income, which was $3 million for the quarter (highlighted in blue).
As a result, we can observe that JC Penney’s gross profit margin did not include depreciation, amortisation, and overhead charges (SG&A).