The Gross Margin Ratio (GMR) formula calculates sales revenue minus cost of goods sold (COGS) and is used to determine a company’s profitability. It is specific to each industry sector and is primarily used by manufacturers and retailers to price their products appropriately. However, GMR should not be the sole financial ratio used to review a company’s financial information. Financial ratio analysis, including benchmarking, is a popular management tool used to determine a company’s financial performance.
Gross Margin Ratio, also known as GMR, is a financial formula that calculates how much sales revenue is left after deducting the cost of goods (COGS) on all items sold. A simple gross margin ratio formula has two parts: Total Sales – COGS = Gross Profit; Gross Profit / Total Sales = GMR. This ratio is important because it allows companies to know how much revenue they are generating through product sales to cover their selling and administrative expenses. Accountants also use this ratio during their financial analysis process to determine how well a company has performed over time and how consistent it was in generating profits.
There is no single standard for determining how strong a company’s gross margin ratio is compared to the general economic market. The relationship is specific to each industry sector because companies must compare their relationships with companies with similar business structures. While gross margin ratio analysis can be used by any company, it is used primarily by manufacturers and retailers who use the ratio to determine whether they have priced their products appropriately to recover all business costs.
Because most companies want to operate at a profit, goods and services must be priced with a small markup added to cost. The gross margin ratio generally represents the additional amount of profit since the formula only includes the sales price and COGS of products and services. Gross margin ratio analysis is a small part of management‘s overall financial ratio analysis used to review a company’s financial information.
Financial ratio analysis is a popular management tool used to break down financial statements presented to internal and external users. The popularity of this management tool stems from the simple calculations traditionally used by accountants to determine how well a business is operating from a financial standpoint. Ratio analysis is also used in conjunction with benchmarking, which compares a company’s financial ratio calculations with a competitor’s ratio analysis. The company with the best ratio estimates generally represents the strongest competitor in the economic marketplace.
However, gross margin ratio analysis should not be used as the sole financial ratio when reviewing a company’s financial information. Businesses are the sum of their total parts; While they may have a strong gross margin ratio, their expenses may be out of control or their overall sales may have declined in recent years. Companies must be broken down by all the financial information reported in their financial statements to determine how strong they are in the economic marketplace.
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