What is gross profit?

As a measure of a company’s profitability, the total revenue figure can only tell us so much about the company’s financial performance. To assess how much money a company really makes, we need to consider how much it costs to produce and deliver its goods and services.

The gross profit is the amount of money that remains after we deduct the costs of goods sold (CGOS) from the total revenue.

This metric helps in examining the costs associated with generating profit. For example, suppose the cost of goods sold increases. In that case, the gross profit value drops, leaving you with less money to cover operating costs. Conversely, profit rises when the cost of goods sold decreases, meaning you will have more money left. Gross profit is a rough estimate of your company’s profit efficiency because it considers the direct costs of selling, but before taking into account overhead and all other costs.

How to calculate gross profit?

Before looking into the gross profit formula, it’s necessary to define the costs of goods sold and revenue. 

Revenue is the total amount of profit your company makes from selling products or services. It shows how much money you’re bringing in from your total sales. However, it does not consider the costs related to your business.

Cost of goods sold (CGOS) is the cost related to producing and delivering your products and services. Some examples of CGOS are raw materials and labor, factory overhead, storage costs, shipping costs, etc. The purpose of finding COGS is to calculate the “true cost” of merchandise sold in a period of time. It helps management and investors monitor the performance of the business. To calculate the gross profit, we must subtract the costs of goods sold from total revenue.

What is the gross profit formula?

The gross profit formula is:

\text {Gross Profit = Revenue – Cost of Goods Sold}

In the equation, revenue is the total amount of money collected from product sales, while COGS is the variable direct costs of producing goods and services, such as raw materials, equipment, employee labor, and shipping.

Gross profit vs. net income 

A business’s profit after deducting all operational, interest, and tax expenses for a certain period of time is known as net income (net profit, or bottom line). To calculate this value, you need to know a company’s gross profit. Net income is the amount of money you are left with after paying all your business expenses, while gross profit is the money you are left with after deducting only the cost of goods sold from revenue.

Calculating the correct values is important because gross profit and net income are interdependent. For example, while gross profit is used to assess a business’s ability to make a profit against its production and labor costs, net income can provide better insight towards the company’s structure and operations – because gross profit factors indirect costs only while net profit factors in all costs and all income.

Gross margin vs. gross profit

Although gross profit and gross margin both use revenue and cost of goods sold (COGS) to calculate a company’s profitability, there is an important difference between the two. Gross profit is a monetary sum, whereas gross margin is a percentage. As a result, gross margin is a valuable indicator for business owners to compare their margin to the industry standard or competitors because it is expressed as a percentage.

For example, if you’re starting a new small business, it wouldn’t make sense to compare your gross profit to those of a larger established competitor with millions of dollars in revenue. Instead, you could compare the two companies gross margins because both companies gross margin percentages are expressed in proportion to the size of each company’s revenue and COGS.

Gross Profit Rate

You can compute the gross profit rate by dividing gross profit by revenue. Assume a company’s revenue is $594,000 and its cost of goods sold is $300,000. $594,000 minus $300,000 is $294,000 in gross profit. The gross profit rate is calculated by dividing $294,000 by $594,000, or 0.49. This means that before selling and administrative costs, 0.49 cents of every dollar sold represents profit. In the course of an accounting period, managers might use the most current gross profit rate to assess projected revenues and costs. The gross profit rate also shows how resource-efficient a company is during the manufacturing process. A company’s gross profit rate can also be compared year to year to see if efficiency is rising or deteriorating.

FAQ

Is gross profit the same as revenue?

Revenue is the amount of money made from selling goods and services. Gross profit is the profit we get after subtracting the goods production and delivery costs from revenue.

What is the difference between gross profit and net profit?

Net profit is the amount of money you are left with after paying all your business expenses, while gross profit is the amount of money you are left with after subtracting only the cost of goods sold from revenue. Gross profit is used to assess a business’s ability to profit against its production and labor costs, and net profit can provide better insight into its structure and operations.

Is gross margin the same as gross profit?

Gross profit refers to a company’s top-line earnings, which are defined as revenue minus direct costs of goods sold. The gross profit margin divides that figure by revenue to determine how much gross profit is earned on a percentage basis after deducting the COGS.

How to calculate gross profit percentage?

The gross profit percentage formula is:
Gross \; Profit \; Percentage \; Formula = Gross \; Profit \div Revenue \times 100 \%

How do you calculate a 20% profit margin?

1.   Express 20% in its decimal form, 0.2.
2.   Subtract 0.2 from 1 to get 0.8.
3.   Divide the original price of your goods by 0.8. That is how much you should charge for a 20% profit margin.
For example, if a product costs $8 to produce, and your gross profit margin is 20 percent, you can calculate your pricing by dividing your cost by (1 – 0.2). In this case, $8 divided by .8 would yield a price of $10.