Gross Profit

Profit after deducting direct costs from sales revenue

What is gross profit?

For an individual, gross profit is simply the salary, wages, tips, capital gains, dividends, interest, rent, pensions earned (before required deductions) from a day of work or from investments made.  From a business operation point of view, gross profit or gross profit is the monetary result obtained after deducting the cost of goods sold and sales returns/allowances from total sales revenue.

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

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.

What is the importance of gross profit in business?

Gross profit serves as the measuring amount in determining the profitability of a business operation. It shows how well sales cover direct costs relating to the production of goods. This is also the amount anticipated by every business owner to know whether it has been worthwhile to have gone into a certain kind of trade or not.