Accounting ratio analysis

[Sijan92]

why does gross profit margin decrease when selling price is reduced??

 

[ahsan99]

Gross profit margin ( as a percentage of sales) is the difference between
Sales and cost of sales /sales * 100 so obviously if selling price is reduced
Sales will decrease , hence the difference between sales and cost of sales will
decrease hence the G.P.M will decrease .

 

[iahmed]

Gross profit margin or profit margin for that matter can be simply defined as the profit made per unit sold. In this case, it's the gross profit made per unit sold. Therefore,a reduction in the selling price of a product will also reduce the profit earned from that product. Another explanation could be made from a mathematical point of view, we know the gp margin formula is gross profit/sales *100. If the sales revenue is decreased then in this case the denominator is decreased thus leading to a lower gp margin figure.

 

[Sijan92]

Sorry i still didn't get it . If selling price is reduced, sales decrease and so does gross profit. This means both the numerator and the denominator will decrese so theres supposd to be no effect at all. And gpm is the gross profit per 100$ worth of units sold. Not gross profit per product sold.

 

[ahsan99]

Sorry i still didn't get it . If selling price is reduced, sales decrease and so does gross profit. This means both the numerator and the denominator will decrese so theres supposd to be no effect at all. And gpm is the gross profit per 100$ worth of units sold. Not gross profit per product sold.

No there isnt anything like "per $100 units" . Refer to the Randall book
Secondly, suppose initially Sales = 10000 Cost of Sales = 5000 So G.P.M 10000-5000/ 10000
50 %...and if selling price(sales) decrease to 8000 then GPM will be 37.5% (3000/ 8000)
The best way to do ANY accounting question , which asks for increase or decrease of GP, NP etc
is to suppose figures and then compare final answer w. intial
Hope this helps

 

[iahmed]

@sijan92 okay, fine. Maybe my mathematical answer was not the most ideal one but let's look at it in this way. If sales revenue goes down due to a decrease in selling price then so will the gross profit. So what happens then? The gross profit margin figure is lower than the previous one.

 

[iahmed]

**The conception that there won't be any effect is wrong. ahsan99 is right, compare new figure with the initial figure.

 

[Sijan92]

okay ishtiaque and ahsan. i get it now. thanks for clarifying..