Gross Profit Margin Excludes These Costs

The gross profit margin helps determine how well a company generates revenue from the cost of producing goods and services. Gross profit margin equals the percentage of revenue that exceeds the cost of goods sold (COGS). The higher the percentage, the more efficient the company generates profit for every dollar of the applicable direct costs.

Calculating Gross Profit Margin

Gross profit is a company's income after subtracting the costs of producing and selling its products. Gross profit is shown as a whole dollar amount and is calculated by: 

Gross Profit = Revenue - Cost of Goods Sold

Gross profit margin is the percentage of profit generated and is calculated by dividing gross profit by revenue as shown below:

Costs Included in Gross Profit Margin

The two components of gross profit and gross profit margin are total revenue and cost of goods sold (COGS). Revenue sits at the top of a company's income statement and is the "top-line number." COGS is the direct costs a company pays to produce its goods and includes:

• Direct materials
• Direct labor
• Equipment costs involved in the production
• Utilities for the production facility
• Shipping costs

What Is Excluded?

Gross profit only includes the costs directly tied to the production facility, while non-production costs like company overhead for the corporate office are not included. There are exceptions whereby a portion of depreciation could be included in COGS and ultimately impact gross profit margin. 

Sometimes the source of the depreciation expense determines whether the expense is allocated as a COGS or an operating expense. If depreciation expenses are included in the cost of goods sold, they will be captured in the gross profit margin.

Below is a portion of JC Penney Company Inc.'s (JCP) income statement as of May 5, 2018:

• Total revenue (in green) was $2.67 billion, while the COGS was $1.7 billion (in red). 
• Gross profit margin was 36%, ($2.67 - $1.7 COGS) / 2.67 = .36 X 100 = 36%
• Operating expenses and overhead, listed as selling, general, and administrative (SG&A), are listed below COGS and go into calculating operating income, which came in at $3 million for the period (highlighted in blue).
• The costs excluded from the gross profit margin are depreciation, amortization, and overhead.

The Bottom Line

A company’s gross profit margin is the money it makes after subtracting the costs of business and production. The metric is expressed as a percentage of sales and may also be known as the gross margin ratio.