Understanding gross profit is key to tracking business growth, assessing overall financial health, and developing strategies to increase profitability. We’ll explore the formula for calculating gross profit and how gross profit compares to profit margin. We’ll also look at why gross profit is important to help you develop this essential business metric. Put simply it’s what a business gets to keep after paying for everything it takes to make or sell its products or services. Gross profit is what a business earns after deducting all of its costs of goods sold (COGS). Operating profit is the money it earns from its day-to-day activities and excludes interest and taxes.
What Does Gross Profit Percentage Mean?
Let’s say you own a small manufacturing company, and you produce guitars that are sold to music shops across the country. Keeping it simple, let’s assume you sell one type of guitar, and you’ve perfected your manufacturing processes to maximize your GPP. In our example, let’s assume the total cost of material in each guitar is $150. It takes a direct labor employee approximately 10 hours, at a rate of $50 per hour to produce each guitar.
Explanation and calculation of gross margin
In other words, the company is becoming more efficient and generating more profits for the same amount of labor and material cost. In our coffee shop example above, the gross profit was $80,000 from revenue of $200,000. The more product made or service rendered, the higher the cost of revenue. Gross profit is your revenue minus the cost of goods sold (COGS), also known as the cost of revenue.
Gross Profit Formula:
Shaun Conrad is a Certified Public Accountant and CPA exam expert with a passion for teaching. After almost a decade of experience in public accounting, he created MyAccountingCourse.com to help people learn accounting & finance, pass the CPA exam, and start their career. Generally Accepted Accounting Principles (GAAP) are the guidelines and rules for financial reporting, issued primarily by the Financial Accounting Standards Board (FASB). GAAP principles are used by all publicly traded companies, as required by the SEC as well as many private companies. Let’s explore some practical examples for better understanding of this topic. Get instant access to video lessons taught by experienced investment bankers.
Gross Profit Percentage Explained in Video
But before any comparisons can be made, the gross profit must be standardized by dividing the metric by revenue. Hence, the profit metric must be standardized by converting it into percentage form. The Gross Profit metric reflects the earnings remaining once a gross profit company’s cost of goods sold (COGS) are deducted from its net revenue. This implies that the services business is more profitable for each dollar of revenue. Both are indicators of a company’s financial health, but they serve different purposes. Investors view consistent gross profit growth as a sign of financial stability, which can positively impact stock prices.
The role of gross profit in the income statement
The principal in this relationship can claim revenue as gross, while the agent must claim revenue as net. We will first use the above data to calculate the Cost of Goods Sold (COGS). In 2025, the corporate tax rate on profits is 21%, reduced from 35% in the 2017 Tax Cuts and Jobs Act. Every business owner must track their business performance regularly… Taylor Josephs is an experienced finance expert with deep knowledge of FP&A.
Presentation of Gross Margin
Net profit is the amount that remains after the company contribution margin has paid not only for the cost of producing goods but also for interest, taxes, and other operating costs over the given period of time. When this amount is negative it is called the net loss and not the net profit. The ultimate goal of every business is to be profitable and make money from their manufacturing. In order to be profitable, the company must be able to sell its goods for an amount that is more than the cost incurred producing them.
- Learn more about what’s included in gross profit and when to calculate gross profit with frequently asked questions about calculating gross profit.
- It controls the production costs, assumes the inventory and the credit risk in its operations, and can choose its suppliers and set prices.
- A company’s gross margin is 35% if it retains $0.35 from each dollar of revenue generated.
- Gross margin helps a company assess the profitability of its manufacturing activities.
- A gross profit report can serve as an early warning sign that you need to tighten the purse strings.
- Net income is calculated by subtracting all operating expenses from gross profit.
It’s a key metric to understand in your business as you analyze your Profit and Loss Statement and understand the economics of the business. Datarails’ FP&A software can help your company implement automation that can help your FP&A team operate more efficiently and effectively. Datarails is helping FP&A teams all over the globe reduce the time they spend on traditional reporting and planning. The accounts receivable turnover ratio is a simple formula to calculate how quickly your clients pay.
Greater financial stability
Conversely, an increasing gross margin means that the company is becoming more efficient or is able to charge higher prices. A good gross profit is relative – it depends on the industry, business model, and market conditions. The key is to ensure efficient cost management, strong pricing strategies, and sustainable margins to maintain financial health. Gross profit margin is a metric that is helpful in analyzing gross profit over time.