EV/Gross Profit Ratio

What is the EV/Gross Profit Ratio?

The EV/Gross Profit Ratio is a profitability financial ratio that estimates the enterprise value of a company to its gross profit. It demonstrates how many dollars of enterprise value are generated for every dollar of gross profit earned. Generally, the lower the ratio, the lower is the company’s net worth. It is calculated as a percentage of enterprise value to the gross profit generated by the company.

What is Enterprise Value?

Enterprise value (EV) is a measure of a company’s total worth or net capitalization. Enterprise value, in its calculation, includes the market capitalization of the company and both its short-term and long-term debt. EV is a popular financial metric used to value a company during a potential takeover.

Enterprise Value = Market Capitalization + Total Debt + Cash & Cash Equivalents

While it is similar to market capitalization in some aspects, enterprise value is different from a simple market capitalization in a few ways. It is a more accurate representation of a company’s net worth, as it includes debt in its calculation.

What is Gross Profit?

Gross profit is a company’s profit after the deduction of the cost of goods sold (COGS). It is also known as sales profit or gross income. Gross profit is calculated by deducting the cost of goods sold from total revenue.

Gross Profit = Total Revenue – Cost of Goods Sold (COGS)

Gross profit is an effective measure to assess a company’s efficiency in producing goods and services. It is a very good indicator of the cost of production and provides insight on whether the cost is too high or too low. Gross profit is often confused with operating profit, which is the total earnings of a company before interest and tax, but after accounting for all fixed costs and operating expenses. The calculation of gross profit involves the deduction of variable costs or the costs of goods sold.

Uses of the EV/Gross Profit Ratio

1. As a measure of profitability

The EV/Gross Profit Ratio is a measure of profitability for a company. It assesses the enterprise value generated for every dollar of gross profit earned.

2. As a measure of net worth

The EV/Gross Profit Ratio is also an effective measure of net worth. Generally, the lower the ratio, the lower is the company’s worth, indicating that the company is undervalued.

3. As a measure of fair value

The EV/Gross Profit Ratio is an accurate measure of the fair value of a company. It is because its calculation accounts for debt. It is exceptionally beneficial during the acquisition process because the acquirer would ultimately end up taking on the debt along with the company’s assets.

Additional Resources

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful:

• Book Value vs Fair Value
• EBIT Guide
• Fixed and Variable Costs
• Operating Income
• See all valuation resources
• See all equities resources