# Gross Profit Margin Ratio

Gross profit margin ratio (GPMR) is one of profitability ratios. It measures how much of each sales dollar remains after costs of goods are deducted. In other words it measures the relative costs of goods sold.

Gross profit margin ratio (GPMR) = Gross Profit/Sales

EXAMPLE:

For example, if ABC has a gross profit of \$1,000,000 and sales of \$3,000,000, then the Gross profit margin ratio (GPMR) is calculated as follows:

= 1,000,000/3,000,000 = 0.3333 or 33%

# Test yourself

Dillon Corporation has a gross profit of \$1,200,000 and sales of \$3,500,000.

Required: Find the Gross profit margin ratio (GPMR)

Solution:

The calculation of  Gross profit margin ratio (GPMR) of Dillon Corporation will be as follows: = 1,200,000/3,500,000 = 0.34 or 34%

Conclusion:

The higher the Gross profit margin ratio (GPMR) the lower the relative cost of goods sold. Therefore, the higher the  Gross profit margin ratio (GPMR), the better.

# Acid-Test Ratio

The acid-test ratio, along with the current ratio analysis, measures liquidity. Liquidity refers to the ability of the firm to meet its short-term obligations (obligations over the next 12 months) with its current assets (excluding inventory). In other words, the ratio allows us to determine the ease with which business can pay its bills as they come due. It is also sometimes referred to as the quick ratio.

A declining ratio is an indicator of declining liquidity, which usually serves as a warning of potential financial difficulties for the business. Such financial difficulties may even result in bankruptcy. The risk of bankruptcy increases further if the ratio falls significantly below 1. A ratio below 1 indicates a situation whereby current assets (excluding inventory) can no longer cover current liabilities.

The formula for the ratio is as follows:

Acid-test ratio = (Current assets – Inventory)/Current liabilities

# Example of an acid-test ratio analysis

Assume Dynasties Inc. has current assets of \$550,000, inventory of \$300,000 and current liabilities of \$300,000. The acid-test ratio of the of Dynasties Inc. is calculated as follows:

\$550,000-\$300,000/\$300,000=0.8

This could indicate a ratio which may be too low. However, acceptable ratio values vary between industries. Therefore, the result must always be used in context via a comparison to industry averages as well as in comparison to the ratio of leading firms in the industry and Dynasties own historical ratio analysis.