Companies can use the gross profit margin to calculate the percentage of sales that are left over to cover indirect costs. After a company figures out how much it costs to cover the direct costs associated with the making and selling of a product, it has to figure out whether it can cover the indirect costs that it must pay for but that aren’t directly associated with the product itself.
Gross profit margin looks like this:
Here’s how to put this equation to use:
Find gross profit and net sales on the income statement.
Divide gross profit by net sales to get the gross profit margin.
A high gross profit margin is a good thing as long as a company isn’t raising prices so high that people stop buying its products. A low gross profit margin may mean that the company is at risk of no longer being able to afford the costs of being in business.
It may end up reducing the workforce or stopping operation entirely as a result of not being able to afford the necessary supporting functions to maintain its core operations.