Day 11 of Fundamental Investing
Next, we start with the Profitability Ratio, the first one here is Gross Margin Ratio.
What is it?
The gross margin ratio is a profitability ratio that compares the gross margin of a business to the net sales. This ratio measures how profitable a company sells its inventory or merchandise. In other words, the gross profit ratio is essentially the percentage markup on merchandise from its cost. This is the pure profit from the sale of inventory that can go to paying operating expenses.
The gross margin ratio only considers the cost of goods sold in its calculation because it measures the profitability of selling inventory. The profit margin ratio on the other hand considers other expenses.
How to calculate it?
Here's an image for the same:
What's its significance?
The gross margin ratio is a profitability ratio that measures how profitable a company can sell its inventory. It only makes sense that higher ratios are more favourable. Higher ratios mean the company is selling their inventory at a higher profit percentage. High ratios can typically be achieved in two ways. One way is to buy inventory very cheap. If retailers can get a big purchase discount when they buy their inventory from the manufacturer or wholesaler, their gross margin will be higher because their costs are down. The second way retailers can achieve a high ratio is by marking their goods up higher.
This obviously has to be done competitively otherwise goods will be too expensive and customers will shop elsewhere. A company with a high gross margin ratio mean that the company will have more money to pay operating expenses like salaries, utilities, and rent. Since this ratio measures the profits from selling inventory, it also measures the percentage of sales that can be used to help fund other parts of the business.
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