Gross profit refers to the total amount that a business earns in net sales after deducting or taking into account all of the variable costs and expenses associated with providing its services and goods such as discounts, allowances, raw materials, factory overhead, etc. Fixed costs or operating expenses like rent, office supplies, health insurance, tax payments, salaries, and interest charges should not be included in this calculation. However, for a service business, the allocated overhead, labor, benefits, and payroll taxes of those who generate billable hours should be considered and reflected as service-related costs.
The Gross Profit Formula
Gross profit = Revenue – Cost of Goods Sold (COGS)
How to Calculate Gross Profit
It’s important to remain consistent in order to report a reliable gross profit figure over time, meaning the cost of goods should be clearly defined throughout the process of aggregating information.
As an example, if XYZ Corporation reports $50,000 in revenue for May and incurred $5,000 in expenses from discounts, $10,000 from raw materials, and $13,000 from factory overhead, it’s gross profit will be $22,000.
Gross profit is considered to be most useful when tracking the trend of a percentage of sales, allowing businesses to drill down into certain time ranges to better understand reasons for reductions or improvements in gross profit change, making it an important metric to track on a business unit level.
Gross profit margin, on the other hand, reveals the amount of money left over from revenue after accounting for the COGS, which is calculated as such:
Gross profit margin = Revenue – COGS / Revenue
The resulting number is typically multiplied by 100 to calculate the figure as a percentage
In positive cases, gross profit margin will reflect a company’s profitability, indicating a sign of success as the percentage of revenue exceeds the amount of costs associated with producing the goods. The higher the gross margin profit ratio, the more efficiently a company is producing and selling its products or services.