Gross profit margin, calculated as sales less cost of goods sold, is commonly used as a key measure of profitability. However, gross profit margin is only useful for comparison between companies, if they are booking the same items in cost of goods sold.
Nordstrom Inc. (JWN) is a fashion specialty retailer offering high-quality apparel, shoes, cosmetics and accessories for women, men and children. One of its competitors is Macy's (M). If we compare JWN's and M's gross profit margins for the past 10 years, it appears that M has outperformed JWN in terms of profitability for a decade. However, using operating margins as an alternative measure of profitability shows a completely different picture.
This is a classic example of how different accounting policies could lead to vastly different reported numbers. JWN records the costs of buying and occupancy as part of cost of goods sold and hence has a lower gross profit margin. On the other hand, M accounts for costs of buying and occupancy as part of selling, general and administrative expenses.
Accounting rules under GAAP and IFRS give companies discretion to include (or exclude) raw materials costs, direct costs such as labour, utilities, rent, and depreciation in costs of good sold. This can distort financial ratios and lead to false and misleading conclusions of a company's superiority over another. Investors are advised to read the financial statements in detail and recast reported numbers for the purpose of analysis.