Gross profit calculation and Gross profit margin

The gross profit is the total revenue subtracted by the cost of generating that revenue. It tells you how much money a business would have made if it didn’t pay any other expenses such as salary, income taxes, etc. The concept behind gross profit is to measure the profitability of a business when not considering its business costs. Essentially, it gives an idea of how profitable the company can be in terms of markup over the production costs for goods or services. Gross profit appears on a corporation’s income statement, which indicates how revenue is turned into net income.

Gross profit calculation

Gross profit is calculated as revenue minus all costs which have direct relation to those sales, whether products or services. Examples of some costs that are deducted to reach the gross profit are expenses incurred for labor, marketing, manufacturing, materials, and selling. Expenses such as salaries or wages, taxes, interest payments, and other overhead costs are not deducted.

      Gross profit = Net sales – Cost of goods sold

Net sales do not include returned items or allowances. Cost of goods sold is also known as cost of sales, and only involves expenses that can be directly attributed to the production and sale of the goods or services.

      Net sales = Sales – Sales returns and allowances.

Gross profit should not be confused with net income:

      Net income = Gross profit – Total operating expenses.

The cost of goods available for sale in any period is to start with the beginning inventory for the period and add the total amount of purchases made during the period then deducting the ending inventory.

Gross profit margin

Gross profit margin is a financial ratio used to assess the profitability of a firm’s core activities, excluding fixed costs.

The general calculation is:

      Gross profit margin=(Revenue-Cost of Sales)/ Revenue

Gross profit margin is expressed as a percentage. For example, if a company receives $25,000 in sales and its cost of goods sold were $20,000, the gross profit margin would be equal to $25,000 minus $20,000, divided by $25,000, or 20%. Basically, 20% gross profit margin means that for every dollar generated in sales, the company has 20 cents left over to cover basic operating costs and profit.

Gross profit margin indicates the relationship between net sales revenue and the cost of goods sold. A high gross profit margin indicates that a business can make a reasonable profit on sales, as long as it keeps overhead costs in control.