Definition: Gross profit percentage is the margin earned (as a percentage) on a product or service after applying the total production cost to the revenue earned. The total costs include the cost of labor, materials, and overhead. The GPP helps to identify the profitability of the organization’s products or services and is often time leveraged as a benchmark against competitors, or industry standards.
What Does Gross Profit Percentage Mean?
What is the definition of gross profit percentage? The gross profit margin is an easy calculation to determine the overall profitability of an organizations products or services. Simply speaking, the percentage is a reliable indicator of the organization’s competency when producing a good or service.
How is the gross profit percentage used and how is it calculated? Management analyzes this metric to track company performance and find ways to increase operational efficiencies. External users, on the other hand, use this metric to compare companies and analyze industry trends. The gross profit percentage formula is calculated as follows:
((Sales – (Total Labor + Materials + Overhead Costs)) / Sales) x 100
Let’s take a look at an example.
Example
Let’s say you own a small manufacturing company, and you produce guitars that are sold to music shops across the country. Keeping it simple, let’s assume you sell one type of guitar, and you’ve perfected your manufacturing processes to maximize your GPP. In our example, let’s assume the total cost of material in each guitar is $150. It takes a direct labor employee approximately 10 hours, at a rate of $50 per hour to produce each guitar.
And finally, the factory overhead rate per guitar has been calculated by the cost accountant to be $100 per guitar. Based on this information, what is the total cost we should use when determining the GPP? The answer is $750, derived by the calculation: $150 material cost + $500 labor cost + $100 overhead cost. After production, each guitar is sold to customers at a sales price of $1,250. So, what’s your GPP? Given that the total sale is valued at $1,250, and the total cost of that sale was calculated at $750, the GPP would be 40%, calculated by the following:
(($1,250 – $750) / $1,250) x 100 = 40%
Summary Definition
Define Gross Profit Percentage: GPP means a financial metric used to calculate the rate of profit earned from producing and selling goods.
