Definition of Gross Margin Ratio
The gross margin ratio is a percentage resulting from dividing the amount of a company's gross profit by the amount of its net sales. (The gross margin ratio is also known as the gross profit margin or the gross profit percentage or simply the gross margin.)
Companies should be continuously monitoring its gross margin ratio to be certain it is sufficient to cover its selling, general and administrative expenses, interest expense, and to earn a profit.
Example of Gross Margin Ratio
To illustrate the gross margin ratio, let's assume that a company has net sales of $800,000 and its cost of goods sold is $600,000. As a result, its gross profit is $200,000 (net sales of $800,000 minus its cost of goods sold of $600,000) and its gross margin ratio is 25% (gross profit of $200,000 divided by net sales of $800,000).
Note: Gross margin ratios vary between industries. Therefore, you should compare a company's gross margin ratio to other companies in the same industry and to its own past ratios or its planned ratios.