What is gross profit?
Gross profit is the money a company makes after subtracting all the costs related to manufacturing, marketing, and selling its products. This means that gross profit measures the profitability and financial performance of your business.
Gross profit basically gives you a snapshot of both how much revenue your business is making and the costs of generating that revenue.
How to calculate gross profit?
Calculating gross profit is easy: just subtract the total cost of goods sold (COGS) from your total sales revenue.
Gross Profit Formula:
Gross Profit = Total Sales Revenue – Total Cost of Goods Sold
What is the cost of goods sold and how to calculate it?
The total cost of goods sold (or COGS) is the sum of all the direct costs and expenses involved in selling your products to customers. This can include:
- The purchase cost of materials
- Production costs
- Sales staff wages
- Shipping costs
- Credit card fees
To calculate the costs of goods sold, you have to total all costs involved in selling the products to customers.
However, the cost of goods sold doesn’t include overhead costs and other business expenses like rent, office equipment, wages of non-sales staff, insurance, or bank costs. These all count as operating expenses, since they’re not directly tied to the sales of your products.
When the total cost of goods sold increases, you’ll have less gross profit—which means you’ll have less money to spend on your business operations.
Gross profit vs. gross profit margin
Only looking at the gross profit figure from one period to another could be misleading when it comes to judging how your store is performing. That’s why it’s also important to measure the gross profit margin.
To calculate your gross profit margin, you’ll need to divide your gross profit by the total sales revenue. Then multiply it by 100 to get the percentage.
Gross Profit Margin Formula:
Gross Profit Margin = (Gross Profit / Total Sales Revenue) x 100
A company’s gross profit could be stable or even increase while the gross profit margin may be on the decline. This happens when an online store is selling a greater number of products, but making less money on each individual sale.
Gross profit margin is an important metric to compare with the industry average. If you’re performing well relative to other businesses in your market, your gross profit margin will be equal to or higher than theirs.
Generally speaking, if your gross profit margin is below expectations or decreasing, you should check which costs are absolutely necessary and which you might consider cutting. The lower the total cost of goods sold, the higher the gross profit margin will be.
Gross profit vs. net profit
Net profit is the amount of money your store earns after deducting all operating costs, administrative costs, income taxes, and other expenses from your gross profit. This is where a company’s overhead costs (which aren’t included in the gross profit formula) are taken into account.
Net Profit Formula:
Net Profit = Gross Profit – Expenses
The net profit shows whether a business is making more than it spends. If the value of net profit is negative, it’s called a net loss.
For a business owner, it’s important to know the difference between net profit and profitability:
- Net profit is an absolute number that is equal to a company’s gross profit minus expenses.
- Profitability is usually shown as a percentage, and it represents the ratio between profit and revenue.
Both of these measures are important indicators of a company’s financial health. The net profit tells you exactly how much money a company generated over a certain time period. A company’s profitability, on the other hand, is a measure of efficiency that tells you how much of the gross profit is being spent on business expenses.
