Assume a gasket manufacturing company has total sales of $75,000 for the accounting period, and the suppliers have rejected one batch worth $1,500 during this period.
Assume the total cost to run the factory during the accounting period as follows:
- Raw materials: $20,000
- Electricity: $7,250
- Packing & delivery: $8,500
- Labor use in production: $7,500
- Support staff wages: $7,000
- Rent: $12,000
- Machinery deprecation: $2,000
- Other administrative costs: $6,000
- Marketing expenses: $5,000
The first step in calculating gross profit ratio is identifying direct costs and eliminating overheads and indirect costs from the list of expenses. This requires elimination of staff wages, rent, marketing expenses, and other administrative costs that do not require consideration when computing input costs.
Total input costs = $20,000 + $7,250 + $8,500 + $7,500 + $2,000 = $25,250
Net Sales = $75,000 (total revenue) – $15,000 (returns) = $735,000
Gross Profit: $735,000 (net sales) - $25,250 (total input costs) = $48,250
Gross Profit Ratio = ($48,250/$73,500) * 100 = 65.64%
In another gross profit ratio example, assume a trading company has stock worth $20,000 at the start of the accounting period, makes additional purchases of $35,000 during the accounting period, and has a stock of $25,000 at the end of the accounting period.
Assume net sales during the period at $50,000 with no refunds or returns.
Input costs = Closing Stock-Opening Stock + Purchases = $25,000 - $20,000 + $30,000 = $35,000
Gross Profit = $50,000 (total revenue) - $35,000 (input costs) = $15,000
Gross Profit Ratio in this case = [$15,000 (Gross Profit) / $50,000 (net sales) ] x 100 = 30%
This means that for every $1 of revenue, 70 cents goes toward meeting the cost of the product sold and 30 cents is available for meeting overhead costs and profits.