Evaluating Profitability

Evaluating Profitability - Evaluating Profitability Gross...

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Evaluating Profitability Gross Profit Rate A company's gross profit may be expressed as a percentage by dividing the amount of gross profit by net sales . This is referred to as the gross profit rate . For PW Audio Supply the gross profit rate is 31.3% ($144,000 ÷ $460,000). Analysts generally consider the gross profit rate to be more informative than the gross profit amount because it expresses a more meaningful (qualitative) relationship between gross profit and net sales. For example, a gross profit amount of $1,000,000 may sound impressive. But if it was the result of sales of $100,000,000, the company's gross profit rate was only 1%. A 1% gross profit rate is acceptable in very few industries. Illustration 5-14 presents gross profit rates of a variety of industries. Illustration 5-14 Gross profit rate by industry A decline in a company's gross profit rate might have several causes. The company may have begun to sell products with a lower “markup ”—for example, budget blue jeans versus designer blue jeans. Increased competition may have resulted in a lower selling price. Or, the company may be forced to pay higher prices to its suppliers without being able to pass these costs on to its customers. The gross profit rates for Wal-Mart and Target, and the industry average, are presented in Illustration 5-15 .
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Illustration 5-15 Gross profit rate Wal-Mart's gross profit rate increased from 23.1% in 2006 to 23.4% in 2007. In its Management
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Evaluating Profitability - Evaluating Profitability Gross...

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