What Is Gross Profit? How to Calculate Gross Profit

A company's gross profit is the amount of income left over after subtracting the total cost of producing and selling its products from its total sales revenue. While total revenue indicates how much money a company receives in exchange for selling its goods, gross profit reflects how much money it actually earns from those sales since it factors in the cost of goods sold (COGS).

Gross profit primarily takes into account a company's variable costs, which are expenses that change based on production volumes, such as sales commissions, direct materials, direct labor, shipping fees, credit card fees on sales, and product packaging. The gross profit metric does not factor in fixed costs, which include items like administrative expenses, rent, depreciation, amortization, and insurance.

Gross profit is a valuable metric because it shows whether a company's production process needs to be more or less cost-effective compared to its revenue. For example, if gross profit decreases due to a spike in shipping costs, you could try to switch to a cheaper shipping service or reduce the weight of your product packaging. In addition, it's important for business owners to analyze gross profit when making product pricing decisions to ensure they're generating enough revenue to cover the cost of goods sold and to maximize profitability.

The biggest drawback of the gross profit metric is that it does not take into account all of a company's expenses and income sources, so it's not useful for determining true profitability. Moreover, you can't compare one company's gross profits to another company’s unless you calculate the gross profit margin, which is the percentage of a company's revenue that's greater than its cost of goods sold (COGS). This financial ratio demonstrates how effectively a business generates revenue compared to managing their production costs.

To calculate the gross profit figure, subtract the cost of goods sold (COGS) from total sales revenue, as seen in this equation:

Gross profit = Revenue - COGS

In the gross profit formula, revenue represents the total amount of money earned from product sales, and COGS represents the variable direct production costs such as raw materials, equipment, employee labor, and shipping. When calculating gross profit, some companies may substitute net sales in place of total revenue. Net sales is similar to total revenue, except it deducts the price of refunded or returned sales, allowances, and discounts.

Gross profit and gross margin both measure a company's profitability using its revenue and cost of goods sold (COGS), but there is one key difference. Gross profit is a fixed dollar amount, while gross margin is a ratio. The fact that gross margin is a percentage makes it a useful metric for business owners to compare their margin against the industry standard or competitors. For instance, if you launch a new small business, it wouldn't make sense for you to compare your gross profits with a large established competitor making millions of dollars more in revenue. Instead, you could compare your gross margins because both gross margin percentages are expressed in proportion to the size of each company's revenue and COGS.

There are different financial metrics you can use to track your company's health and compose your company's financial statements:

1. 1. Gross profit: Gross profit is the amount of income left over after subtracting the cost of goods sold (COGS) from the total sales revenue. This metric indicates whether a company’s production process needs to be more or less cost-effective in comparison to its revenue.
2. 2. Net income: Calculate the net income metric by subtracting total expenses from total revenue to see exactly how much a company profits (a new profit) or loses (a net loss). A company's net income over time is a great indicator of how well or poorly its management team runs the company. Net income is also called net profit, net earnings, or bottom line.
3. 3. Operating profit: To calculate operating profit or earnings before interest and taxes (EBIT), subtract operating expenses—which include overhead costs like rent, marketing, insurance, corporate salaries, and equipment—from gross profit. Investors find EBIT useful in determining a company's financial performance because it doesn't factor in items that are out of the management team's control.
4. 4. Gross profit margin: A gross profit margin is the percentage of revenue generated that's greater than the COGS. To calculate gross profit margin, divide gross income by revenue and multiply the result by 100.
5. 5. Net profit margin: Net profit margin is the ratio of net profit to total revenue expressed as a percentage. To calculate net profit margin, divide your net income by total revenue and multiply the answer by 100.

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