Gross profit percentage
| Gross profit percentage |
= |
Gross Profit x 100 / Gross revenue |
This is one of the many ratios used by auditors in ratio
analysis. As with other ratios, the auditor compares the actual
value of the ratio at a point of time with the expected value of
the ratio and investigates any unexpected change. To avoid the
actual value of the ratio biasing the auditor's estimation of the
expected value, auditors estimate the expected value before
calculating the actual value.
Depending on the nature of the client's business, and changes to
it during the year, small variations in the gross profit percentage
may or may not be significant. In some businesses, an increase in
this percentage of 0.25% may be significant. Large variations,
however, will always require investigation.
By itself, the ratio does not convey a lot of meaning. Comparison
of the ratio provides more meaningful information. For example:
- Comparison of the ratio with an industry average (ensuring the method of calculating the industry ratio is the same method used to calculate the client's ratio). This provides
an indication of whether the client is performing better or worse
than the industry as a whole. The comparison is useful when
obtaining a preliminary knowledge of the
client's business.
- Comparison of the ratio between different divisions within an
entity. This comparison provides an indication of which divisions may require
further investigation. The comparison is useful when obtaining a
detailed knowledge of the client's
business.
- Comparison of the ratio this year with last year. An increase
in the ratio over the previous year may be an indication that cost
of sales is understated (including, for example, an overstatement
of closing inventory) or that revenue is overstated; a decrease may
indicate that cost of sales is overstated or that gross revenue is
understated. (Where monthly figures are available, an examination
of the ratio for the last two months of the financial year could
assist in highlighting any adjustments made to revenue and cost of
sales at year end.) In many instances, however, a change in this
ratio is due to a change in production methods, product mix, or
some other legitimate reason.
Other ratios used by auditors include:
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