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Calculating gross profit margin and net profit margin

From: Excel 2007: Financial Analysis

Video: Calculating gross profit margin and net profit margin

One of the most basic measures of profitability is how much money a company makes on each item it sells. You can analyze a company's profit by subtracting the cost of goods sold from total revenue and then dividing that result by total sales revenue. The result is the gross profit ratio. A company's gross revenue ignores all expenses except the cost of goods sold. In industry lingo, gross revenue is Earnings Before Interest, Taxes, Depreciation, and Amortization or EBITDA. So here in the worksheet, you can see that we have the Sales Revenue and the Cost of Goods Sold.

Calculating gross profit margin and net profit margin

One of the most basic measures of profitability is how much money a company makes on each item it sells. You can analyze a company's profit by subtracting the cost of goods sold from total revenue and then dividing that result by total sales revenue. The result is the gross profit ratio. A company's gross revenue ignores all expenses except the cost of goods sold. In industry lingo, gross revenue is Earnings Before Interest, Taxes, Depreciation, and Amortization or EBITDA. So here in the worksheet, you can see that we have the Sales Revenue and the Cost of Goods Sold.

So again what we're going to do is subtract cost of goods sold from sales revenue and then divide it by sales revenue to get the gross profit margin. So = (B5-B6/B5), press Enter, and there is our ratio, 0.56. You can calculate a company's gross profit margin for all of its products, but you can also break the numbers down by product to get an idea of how efficiently a product contributes to the company's bottom line. Some companies follow what's called a Loss Leader Strategy, where they sell one item such as a razor at a loss, because the ancillary products such as razor blades generate substantial profits.

Another example of this Loss Leader Strategy comes from the video game console market. Companies often sell their consoles at a loss and make up the difference in game sales. In those cases it might make sense to consider the products as a group and not individually. Calculating a company's gross profit margin tells us how effectively the company earns money with its products, but it ignores expenses such as interest, depreciation and taxes. Because investors need to know more about a company's finances than simply the amount of money it makes on each sale, you can calculate the Net Profit Margin, which takes interest, tax, depreciation and amortization expenses into account.

Because of that, it's a true measure of a company's ability to generate cash in excess of its expenses. To calculate a company's net profit margin, you subtract all interest, tax, depreciation and amortization expenses from the company's sales revenue and then divide the result by sales revenue. That also includes cost of goods sold. So on this worksheet, we have the sales revenue and then we have all of the cost, not just cost of goods sold. So to calculate the Net Profit Margin, we have a formula that subtracts all of the cost from B5, the sales revenue.

So we have sum of B6-B10, and these are the costs, and divide that result by the sales revenue, which is in cell B5. The result is the Net Profit Margin, which reflects a company's true ability to generate profits. Calculating the Net Profit Margin for individual products can generate different results based on how the company assigns its overhead cost. For example, a company might need to take out a loan so they can manufacture a product, in which case the company can assign that facility's interest, depreciation and amortization expenses to the product's account.

In many cases though, the company will spread the burden of taxes, interest, depreciation and amortization across all of its product lines. Also, it's not unusual for a company's gross and net profit margins to vary by season. Many retail businesses rely on brisk holiday sales to turn their profit for the year. Companies with consistently high profit margins relative to other companies in their market sector sell products efficiently and keep their operating expenses in check. The cash they generate can be distributed to shareholders as dividends making the company more attractive to investors or be used for research and development to enhance their products.

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Excel 2007: Financial Analysis

51 video lessons · 13992 viewers

Curt Frye
Author

 
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  1. 2m 6s
    1. Welcome
      1m 8s
    2. Using the exercise files
      32s
    3. Disclaimer
      26s
  2. 13m 20s
    1. Separating inputs and formulas
      2m 2s
    2. Avoiding common mistakes
      5m 39s
    3. Tracing formula precedents and dependents
      2m 52s
    4. Evaluating Excel formulas step by step
      2m 47s
  3. 18m 40s
    1. Tracking income and expenses using an Excel table
      3m 29s
    2. Creating a Pivot Table from table data
      3m 36s
    3. Pivoting a Pivot Table
      2m 22s
    4. Filtering a Pivot Table
      3m 11s
    5. Adding Pivot Table columns to enhance data analysis
      3m 5s
    6. Tracking cash flow using a Pivot Chart
      2m 57s
  4. 18m 48s
    1. Reading a corporate financial statement
      6m 1s
    2. Introducing common-sizing strategies for analyzing financial statements
      3m 59s
    3. Creating common-sized income statements
      3m 1s
    4. Creating common-sized balance sheets
      2m 53s
    5. Calculating percentage changes in financial statements
      2m 54s
  5. 8m 12s
    1. Calculating earnings per share
      1m 54s
    2. Calculating return on equity and return on assets
      2m 50s
    3. Calculating gross profit margin and net profit margin
      3m 28s
  6. 6m 19s
    1. Calculating the current ratio and quick ratio
      2m 47s
    2. Calculating the average collection period
      1m 56s
    3. Calculating inventory turnover
      1m 36s
  7. 6m 12s
    1. Calculating the equity ratio
      1m 26s
    2. Calculating the debt ratio
      2m 57s
    3. Calculating the times interest earned ratio
      1m 49s
  8. 10m 58s
    1. Calculating simple interest and compound interest
      3m 36s
    2. Applying nominal versus effective interest rates (APR versus APY)
      3m 21s
    3. Calculating the number of days between events
      4m 1s
  9. 13m 32s
    1. Computing the future value of an investment
      3m 30s
    2. Calculating present value
      2m 29s
    3. Calculating net present value
      2m 42s
    4. Calculating internal rate of return
      2m 24s
    5. Calculating NPV and IRR for uneven input periods (XNPV and XIRR)
      2m 27s
  10. 7m 30s
    1. Projecting future results using the Forecast function
      2m 9s
    2. Performing quick forecasts using the Fill handle
      2m 57s
    3. Adding a trendline to a chart
      2m 24s
  11. 22m 28s
    1. Introducing amortization
      2m 20s
    2. Calculating payments on a fully amortized loan
      2m 21s
    3. Calculating payments on a partially amortized loan (balloon payments)
      2m 4s
    4. Calculating interest and principal components of loan repayments
      5m 32s
    5. Introducing depreciation
      2m 1s
    6. Calculating straight line depreciation
      1m 30s
    7. Calculating declining balance depreciation
      3m 24s
    8. Calculating double declining balance depreciation
      3m 16s
  12. 9m 34s
    1. Introducing bonds and bond terminology
      1m 37s
    2. Calculating a bond's yield
      2m 15s
    3. Calculating the value of zero coupon bonds
      3m 18s
    4. Pricing bonds to be offered to investors
      2m 24s
  13. 23s
    1. Goodbye
      23s

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