Gross Profit: Meaning, Formula, and Real-World Examples
Gross profit is the profit after subtracting the direct costs associated with a sale.
What is Gross Profit?
Gross profit is the revenue minus the direct cost of producing the product or service. Gross profit is a metric shown on the income statement of companies and may also be referred to as gross margin or gross income.
Gross Profit Formula
The formula to calculate gross profit is:
Gross Profit = Total Revenue – Cost of Goods Sold
Total revenue is the sales generated by a company’s operations and it is calculated as the price multiplied by the quantity sold.
Cost of goods sold (COGS) is the direct cost associated with producing the product or service. Common COGS items include:
- Raw materials to make the product.
- Labor costs to manufacture the product.
- Shipping and packaging costs.
- Freight-in costs.
For publicly-traded companies, gross profit can be found on the income statements right after the COGS line item. See lower in the article for an example using Microsoft’s income statement.
Gross Profit Example
Suppose company A has a total revenue number of $50,000. The costs associated with producing its products are:
- Materials: $5,000
- Shipping Costs: $1,000
- Labor: $7,000
- Packaging Materials: $500
To get the COGS total, the above line items need to be added together. In this example, COGS equals $13,500. The gross profit formula would be $50,000 - $13,500 which is $36,500.
Real-World Gross Profit Example: Microsoft
Below have Microsoft’s 10Q for the first quarter of 2022. In it, we can find the gross profit, which in this case is labeled as gross margin.
Microsoft has split revenue into product and service revenues. The same split also applies to cost of goods sold, which is labeled cost of revenue in this case. Typically, large companies with several offerings split their revenue into products and services for further context.
By taking the total revenue and subtracting the total cost of revenue, we can derive the gross margin. In Q1 of 2022, Microsoft’s gross profit was $34,670,000,000. Note that the figures on the income statement are in millions.
Is Gross Profit Margin the Same as Gross Profit?
Gross profit and gross profit margin are not the same thing, but they are related. Once the gross profit has been calculated, it’s simple to find the gross profit margin. The gross profit margin formula is:
Gross Profit Margin = Gross Profit / Revenue
The answer will be a percentage that showcases a company’s performance. If a company’s gross profit margin has major fluctuations from month to month, it’s likely that production is not being managed well or that sales are not remaining steady. Adjusting factors like the price of a product, negotiating for cheaper raw materials, and effective marketing campaigns can all result in gross profit margin changes.
Gross profit margin is also used by stock market analysts and individual investors to compare one company to another. If two companies prepare products that are similar and have a comparable price point, the gross profit margin will highlight any competitive advantages that one company has over the other.
What is the Difference Between Gross Profit and Net Income?
Net income is the money remaining after subtracting all expenses while gross profit only subtracts the direct costs associated with producing the product. Both metrics are relevant to stakeholders looking to determine the health of a company.
Gross profit shows how effective a company is at managing production. It helps answer questions about a company such as:
- Are they being strategic about their supplier partnerships?
- Do they reduce the amount of time and manpower it takes to produce products when necessary?
- Are the machines operating efficiently and kept in good shape?
Net income highlights a more complete picture but makes it hard to single out the production aspect of a company. The metric answers questions like:
- Does the company manage rent costs, utility costs, and non-production payroll costs well?
- Are smart tax strategies being used year-over-year?
- Does the price of each product sufficiently cover the costs associated with running the business as a whole?
How to Increase Gross Profit
To increase gross profit, there are two areas businesses can adjust: total revenue and cost of goods sold. To boost total revenue, a company can increase its pricing, sell more units, or both. To do so, it can invest in marketing campaigns to rebrand as a more luxurious product or expand to a broader market to capture more customers.
On the cost side, any cost of goods sold items decreasing will boost gross profit. As such, reducing shipping costs, manufacturing costs, or costs of raw materials are ways to increase gross profit.
Gross Profit FAQ
Q: Is gross profit the only metric to pay attention to when assessing a company’s financial health?
A: No, there are many metrics to look at when you’re trying to determine the overall health of a company. Net profit margin, working capital, and cash flow are just a few of the other metrics that help provide a complete financial picture for individual businesses.
Q: Is gross profit the same as net profit?
A: No, as explained above, gross profit only subtracts the cost of goods sold from total revenue numbers. The net profit calculation subtracts all business expenses from total revenue to get the answer.
Additional Resources
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