What is gross profit?
Behind every successful business lies a simple, but crucial, concept: profit.
At its core, profit is the difference between the money a company earns and the money it spends. It’s what allows a business to grow, invest in new products, and create jobs.
One type of profit, in particular, is especially important: gross profit.
It’s the bedrock of a company’s financial health, providing a clear picture of how much money it’s making from selling its products or services.
So, whether you’re an entrepreneur just starting out or a seasoned business owner looking to fine-tune your strategy, read on to learn everything you need to know about gross profit.
- What is gross profit?
- How do I calculate gross profit?
- What are examples of gross profit?
- What is gross profit margin?
- Gross profit vs net profit
- How do you calculate net profit?
What is gross profit?
Gross profit is a financial term used to describe the amount of money a company makes after deducting the cost of goods sold (COGS) from its revenue. In simple terms, it’s the profit a company earns from selling its products or services.
You can use gross profit to make decisions about pricing, production, and sales strategies.
However, it’s important to note that gross profit doesn’t consider other expenses, such as operating expenses, taxes, any fixed cost and interest. It’s not a complete measure of a company’s profitability.
How do I calculate gross profit?
Calculating gross profit is easy. You need to subtract the cost of goods sold (COGS) from the revenue generated by the sale of goods or services.
Gross Profit = Total Revenue – Cost of Goods Sold (COGS)
To calculate COGS, you need to add up all the costs directly related to producing or acquiring the goods or services sold, including the cost of materials, labour, and overhead expenses.
The gross profit formula is –
COGS = Beginning Inventory + Purchases during the period – Ending Inventory
Once you have calculated COGS, you can use it in the gross profit formula to calculate the business’s profitability.
For example, let’s say a clothing company generates $100,000 in revenue from selling clothes and has $60,000 in costs to produce those clothes.
So, the gross profit formula would be –
Gross Profit = $100,000 – $60,000 = $40,000
In this case, our gross profit calculation is $40,000, which can be used to cover other expenses and generate net income.
What are examples of gross profit?
What exactly do gross profits look like for different businesses?
Retail stores: A retail store sells products to consumers, and generates gross profit from the difference between the price it charges for the products and the cost of acquiring or producing those products.
Manufacturing companies: A manufacturing company produces goods, such as furniture or machinery, and generates gross profit from the difference between the selling price of the goods and the cost of raw materials, direct labor costs, and overhead expenses involved in producing those goods.
Service-based businesses: Law firms, accounting firms, consulting firms and the like, generate gross profit from the fees they charge for their services, less any direct costs associated with providing those services.
Food and beverage businesses: Restaurants, cafes, and other food and beverage businesses generate gross profit from the difference between the price of the food and beverages they sell and the cost of the ingredients, labour, and overhead expenses involved in preparing and serving those items.
Online retailers: Online retailers, such as Amazon or eBay, generate gross profit from the difference between the price they charge for the products they sell and the cost of acquiring or producing those products, as well as any shipping or fulfilment costs.
To understand gross profit, you will need to know about gross profit margin.
What is gross profit margin?
The gross profit margin is simply the percentage of revenue that remains after deducting the cost of goods sold (COGS).
The formula for calculating the gross margin is as follows:
Gross Profit Margin = (Gross Profit / Total Revenue) x 100%
To work out the gross margin of our clothing example, if a company has $100,000 in gross income and $60,000 in COGS, the gross profit is $40,000, and the gross profit margin formula is:
Gross Profit Margin = ($50,000 / $100,000) x 100% = 40%
This means that for every dollar of revenue generated by the company, 40 cents are available to cover other expenses and generate net income.
The higher the gross profit margins, the more profitable the business is, as it indicates that the company can sell its products or services at a higher price than the cost of producing or acquiring them.
Gross profit vs net profit
Oh, one more thing.
You’ll need to look at a net profit for a more comprehensive picture of a company’s financial health.
The main difference between gross profit and net profit is that gross profit is the profit a company makes after deducting the cost of goods sold (COGS) from its revenue, while net profit considers all costs associated with running the business and provides a more complete picture of the company’s overall profitability.
How do you calculate net profit?
To calculate net profit, you deduct all expenses, including COGS, fixed costs, operating expenses, interest, taxes, and other costs, from the revenue.
Again, let’s go back to our clothing example.
In our above example, your clothing company’s gross profit was $40,000 for the year, after deducting the cost of goods sold (COGS) from its revenue.
However, the company also had operating expenses (such as rent (and other fixed costs), salaries, and marketing costs, office supplies) totalling $15,000, as well as interest expenses of $3,000 and taxes of $5,000.
We need to subtract all of these additional expenses from the gross profit. So:
Net profit = Gross profit – Operating expenses – Interest expenses – Taxes
$40,000 – $15,000 – $3,000 – $5,000
Net profit = $17,000
$17,000 is the amount of money that the company made after deducting all of its expenses, not just the cost of goods sold.
This profit is a more comprehensive measure of a company’s profitability than the gross profit since it takes into account all of the costs of doing business.
Need help calculating your profits to evaluate what your business makes and its profitability – and making decisions about its future growth and investment? We can help. Speak to an accountant on +61 2 9100 0480 or ask a question using our chatbox below.