Gross Profit: What It Is and Examples

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Gross profit is the difference between net sales revenue and the cost of goods sold. It is one of the most important items on your company’s income statement.

Your company’s gross profit can instantly tell you, investors, bankers and business partners if your business is making money.

Gross profit can also give you navigational information to help your business reach its desired destination, whether that’s more profits, more customers, a greater market share or increased brand recognition.

We’ll help you better understand gross profit, how to calculate it and when it comes into play.

What is gross profit?

Gross profit is how much money your business made minus the cost of the goods and services it sells.

High gross profit, for example, suggests you’re steering your company’s ship in the right direction. But low gross profit indicates you may need to adjust your management, marketing, team or operations — perhaps even all of the above — to make your business more viable.

Pocketing your money, though, is not the same as keeping it. Unlike net profit — which is the money your business takes home after all its bills are paid — gross profit is the pool of money from which your business pays those bills, including overhead like rent, utilities, insurance, payroll, advertising and taxes.

Say your hypothetical business, Widgets Co., sells widgets. Its gross profit is the money it earns from widget sales, deducting what it paid to make or acquire the widgets. Widgets Co. uses that money to pay for office space, staff and other overhead. What’s left over — the bottom line — is net profit, not gross.

Here’s what Widgets’ Co.’s income statement might look like:

Widgets Co. Income Statement

Revenue
Net Sales Revenue$500,000
Cost of Goods Sold$150,000
Gross Profit$350,000
Operating Expenses
Payroll$150,000

How to calculate gross profit

Calculating gross profit is easy. To do it, you need to know two things: net sales revenue (how much money your company made selling its products or services, minus any returns or discounts) and cost of goods sold (what your business spent to produce or acquire its products, or to deliver its services).

Determining the net sales revenue should be straightforward. The latter, however, can be tricky. Again, imagine your company makes widgets. Its cost of goods sold includes not only what it paid the factory to manufacture them, but also the variable costs of the underlying raw materials, labor, utilities and freight charges.

Once you know your net sales revenue and your cost of goods sold, gross profit is a simple calculation.

Here’s the gross profit formula:

Net sales revenue - cost of goods sold = gross profit

Applying it your business

Instead of widgets, imagine your company makes clothing and sells it online. In its first year of business, XYZ Clothing Co. sells $1 million worth of products directly to consumers via its website. Over the course of the year, it holds several sales, produces numerous coupons and accepts regular returns from unsatisfied customers. Together, discounts and returns total $100,000, which brings the net sales revenue down to $900,000. The company pays $650,000 for the fabric, labor, production and shipping of its clothing. Its gross profit, therefore, is $900,000 minus $650,000, which is $250,000. That’s $250,000 that XYZ Clothing Co. can use for fixed costs, such as renting offices, maintaining a website and paying administrative staff.

But gross profit alone isn’t always useful. Accountants, business owners and investors often go a step further by calculating gross profit margin, which expresses gross profit not as a dollar amount but as a percentage of net sales. In doing so, it becomes possible to establish internal and external benchmarks, which you can use to track your performance over time and in comparison to peers and competitors to determine whether you’re underperforming.

The formula for gross profit margin is:

(Gross profit / net sales revenue) x 100 = gross profit margin

Therefore, in its first year of business, XYZ Clothing Co.’s profit margin would be $250,000 divided by $900,000, multiplied by 100, which is 27.8%. Or put another way: XYZ Clothing Co. keeps about 28 cents out of every $1 it earns.

What qualifies as a healthy gross margin can vary dramatically depending on the industry. In general, though, the U.S. Small Business Administration (SBA) states healthy businesses have a gross profit margin of at least 30%.

In this example, XYZ Clothing Co. would need to improve its gross profit margin during its second year of business. It can do so by either increasing net sales revenue (e.g., increasing prices, selling more product and offering fewer discounts) or by reducing its cost of sales (e.g., using cheaper raw materials, finding a more affordable factory and negotiating better shipping rates).

In its second year, imagine that XYZ Clothing Co. increases its net sales revenue to $950,000 and reduces its cost of sales to $600,000. Now, its gross profit and gross profit margin are $350,000 and 36.8%, respectively.

Why gross profit matters

Because they reflect financial inflows relative to financial outflows, gross profit and gross profit margin are reliable weather vanes by which to judge your company’s performance. As an exercise, that can be useful in a variety of circumstances. As demonstrated in the previous XYZ Clothing Co. illustration, for example, gross profit can help you determine that you need to raise your prices or reduce your cost of sales, or sometimes both.

Gross profit can be especially useful when you calculate it for individual products and services instead of for the business as a whole. A restaurant, for example, can calculate gross profit for every item on its menu. To increase net profit, it might subsequently drop items from its menu that have the lowest gross profit margin. A manufacturing business can similarly calculate the gross profit of a potential new product to decide if adding it will help or hurt the company.

Gross profit also can be a barometer for competitiveness. They can confirm or refute a company’s position in the marketplace. After all, a business that claims to be a market leader, to have a superior product or to have an attractive brand should be able to charge premium prices. It should, therefore, have a higher gross profit margin than its competitors.

The same is true for a company that claims to be lean and efficient. If it is, that will be reflected in its gross profit margin.

Because gross profit reflects a company’s health and competitiveness, expect it to come into play when your business seeks outside capital — from a bank, for instance, or investors, both of which will analyze gross profit as part of their decision when providing a loan or making an investment. The bottom line If your company’s financials were a novel, gross profit would be a single chapter — not the entire book. Still, it tells an important part of the story.

Whether your goal is making more money, qualifying for bank financing or increasing market share, it pays to master the practice of not only calculating gross profit, but also reacting with sound business decisions that grow the bottom line.

FAQ

What's the formula for gross profit?

Net sales revenue - cost of goods sold = gross profit.

What's the meaning of gross profit?

Gross profit is how much money your business made minus the cost of the goods and services it sells.

Is revenue the same as profit?

Revenue is an important component in calculating your profit but it isn't the same as profit as revenue doesn't take into account costs.

What's the target gross operating profit?

Gross operating profits will differ by business and industry.

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