The gross profit ratio or gross profit margin ratio expresses the relationship of gross profit on sales / net sales. gross profit margin ratio indicates the gross margin of profits on the net sales and from this margin only, all expenses are met and finally net income emerges. The basic components for the computation of this ratio are gross profits and net sales. `net sales’ means total sales minus sales returns nd `gross profit’ means the difference between net sales and cost of goods sold. The formula used to compute gross profit ratio is:
Gross Profit Ratio =(gross profit/net sales)x100
Gross profit ratio indicates to what extent the selling prices of goods per unit may be reduced without incurring losses on operations. A low gross profit ratio will suggest decline in business which may be due to insufficient sales, higher cost of production with the existing or reduced selling price or the all-round inefficient management. A high gross profit ratio is a sign of good and effective management.