| Preview: Analyzing an Income Statement |
| Here's a Sneak-Peak at the Upcoming Lesson 4 - Page 2 |
Gross Margin
Although we are only a few lines into the income statement, we can already calculate our first ratio. The gross margin is a measurement of a company’s manufacturing and distribution efficiency. A company that boasts a higher percentage than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors.
To calculate Gross Margin, use this formula:
Gross Profit
--------------------------------------
Net Sales (the Total Revenue)
Let’s apply to this to a fictional company, Greenwich Windmills.
|
Greenwich Windmills In thousands except earnings per share |
||
|
Fiscal year ended |
Sep 30, 2001 |
Oct 1, 2000 |
|
Total Revenue |
$405,209 |
$315,000 |
|
Cost of Sales |
$243,125 |
$189,000 |
|
Gross Profit |
$162,084 |
$126,000 |
Let’s assume the average Windmill company has a gross margin of 30%.
The first thing you will notice is that the net sales figure isn’t present. Management decided to use the term total revenue, which earlier learned is the same thing. Plugging the information into our formula, we find that Greenwich Windmills has a gross margin of 40%. This tells us that they are more efficient in the production and distribution of their product than most of their competitors.
Putting It Together Thus Far:
We’ve actually covered a lot of
ground. Let’s reiterate everything we’ve discussed.
If the owner of an ice cream parlor purchased 10 gallons of vanilla ice cream for $2 per gallon, and sold each of those gallons to her customers for $5, the first three lines on her income statement would look something like this:
Total Revenue $50
(The total revenue is the amount of money rung up at the cash register. The owner sold 10 gallons of vanilla ice cream to her customers for $5 per gallon. 10 gallons x $5 a gallon = $50.)
Cost of Revenue $20
(The cost of goods sold was 10 gallons x $2 per gallon = $20)
Gross
Profit $30
(The total revenue subtracted by the cost to earn that revenue is $30. Before
taxes, and other expenses, this is the ice cream parlor’s gross profit.)
Gross Margin: .6 (or 60%)
|
|
