Gross Profit

Profit after deducting direct costs from sales revenue

What is gross profit?

The Gross Profit (GP) of a business is the accounting result obtained after deducting the cost of goods sold and sales returns/allowances from total sales revenue.  GP is located on the income statement (sometimes referred to as the statement of profit and loss) produced by a company and is used in determining a company’s gross margin.   Below is an example:

Gross Profit

 

What is the formula for gross profit in a business operation?

The gross profit formula is:

Gross profit = Sales Revenue – Cost of Goods Sold

 

To illustrate:

As of the first quarter of business operation for the current year, a bicycle manufacturing company has sold 200 units for a total of $60,000 in sales revenue. However, it has incurred $25,000 expenses both for spare parts and materials as well as direct labor costs. There were also returns and allowances for a total of $1,000. As a result, the gross profit or profit declared in the financial statement for Q1 is $34,000 ($60,000 – $1,000 – $25,000).

 

What is Sales Revenue?

Sales revenue or net sales is the monetary amount obtained from selling goods and services to business customers excluding the merchandise returned and the allowances/discounts offered to them.  This can be realized either as cash sales or credit sales.

 

What is Cost of Goods Sold?

Cost of goods sold or cost of sales is an expense incurred for directly creating a product which includes the raw materials and labor costs applied to it. However, in a merchandising business, cost incurred is usually the actual amount of the finished product (plus shipping cost if any) purchased by a merchandiser from a manufacturer or supplier. In both types of business, cost of sales is properly determined through an inventory account or list of raw materials or goods purchased maintained by the owner or company.

 

Gross margin

Gross profit serves as the measuring amount in determining the gross profitability of a business operation. It shows how well sales cover direct costs relating to the production of goods.

 

The formula for gross margin is:

Gross Margin = Gross Profit / Total Revenue x 100

 

Gross margin is expressed as a percentage.  For example, a company has revenue of $500 million and cost of goods sold of $400 million, therefore their gross profit is $100 million.  To get the gross margin, divide $100 million into $500 million which results in an answer of 20%.

 

Additional resources

Thank you for reading this guide!  CFI’s mission is to help you become a world class financial analyst.  With that mission in mind, these additional resources will help you advance your career: