What Is Gross Profit? - Investopedia

Key Takeaways · Gross profit, also called gross income, is calculated by subtracting the cost of goods sold from revenue. · Generally, gross ... TableofContents Expand TableofContents WhatIsGrossProfit? Formula WhatGrossProfitCanTellYou GrossProfitvs.GrossProfitMargin GrossProfitvs.NetIncome HowtoCalculateGrossProfit AdvantagesofUsingGrossProfit Limitations GrossProfitFAQs TheBottomLine CorporateFinance FinancialStatements Investopedia/TheresaChiechi WhatIsGrossProfit? Grossprofitistheprofitacompanymakesafterdeductingthecostsassociatedwithmakingandsellingitsproducts,orthecostsassociatedwithprovidingitsservices.Grossprofitwillappearonacompany'sincomestatementandcanbecalculatedbysubtractingthecostofgoodssold(COGS)fromrevenue(sales).Thesefigurescanbefoundonacompany'sincomestatement.Grossprofitmayalsobereferredtoassalesprofitorgrossincome. KeyTakeaways Grossprofit,alsocalledgrossincome,iscalculatedbysubtractingthecostofgoodssoldfromrevenue.Generally,grossprofitonlyincludesvariablecostsanddoesnotaccountforfixedcosts.Grossprofitassessesacompany'sefficiencyatusingitslaborandsuppliesinproducinggoodsorservices.Grossprofit,whichonlyreflectsthecostofgoodssold,isdifferentthannetprofitwhichfactorsinallcompany-wideexpenses.Aderivativeofgrossprofitisgrossmargin,amarginthatindicateswhatpercentofrevenueacompanyearnscanbeappliedtowardscompanyoperatingcosts. 1:37 GrossProfit FormulaforGrossProfit Gross profit = Net sales − CoGS where: Net sales = Equivalent to revenue, or the total amount of money generated from sales for the period. It can also be called net sales because it can include discounts and deduc- tions from returned merchandise. Revenue is typically called the top line because it sits on top of the income statement. Costs are subtracted from revenue to calculate net in- come or the bottom line. CoGS = Cost of goods sold. The direct costs associated with producing goods. Includes both direct labor costs, and any costs of materials used in producing or manufacturing a company’s products. \begin{aligned}&\text{Grossprofit}=\text{Netsales}-\text{CoGS}\\&\textbf{where:}\\&\text{Netsales}=\text{Equivalenttorevenue,orthe}\\&\text{totalamountofmoneygeneratedfromsales}\\&\text{fortheperiod.Itcanalsobecallednetsales}\\&\text{becauseitcanincludediscountsanddeduc-}\\&\text{tionsfromreturnedmerchandise.Revenue}\\&\text{istypicallycalledthetoplinebecauseitsits}\\&\text{ontopoftheincomestatement.Costsare}\\&\text{subtractedfromrevenuetocalculatenetin-}\\&\text{comeorthebottomline.}\\&\text{CoGS}=\text{Costofgoodssold.Thedirectcosts}\\&\text{associatedwithproducinggoods.Includesboth}\\&\text{directlaborcosts,andanycostsofmaterials}\\&\text{usedinproducingormanufacturingacompany's}\\&\text{products.}\end{aligned} ​Gross profit=Net sales−CoGSwhere:Net sales=Equivalent to revenue, or thetotal amount of money generated from salesfor the period. It can also be called net salesbecause it can include discounts and deduc-tions from returned merchandise. Revenueis typically called the top line because it sitson top of the income statement. Costs aresubtracted from revenue to calculate net in-come or the bottom line.CoGS=Cost of goods sold. The direct costsassociated with producing goods. Includes bothdirect labor costs, and any costs of materialsused in producing or manufacturing a company’sproducts.​ WhatGrossProfitCanTellYou Grossprofitassessesacompany'sefficiencyatusingitslaborandsuppliesinproducinggoodsorservices.Themetricmostlylooksatvariablecosts—thatis,coststhatfluctuatewiththelevelofoutput,suchas: Materials Directlabor,assumingitishourlyorotherwisedependentonoutputlevels Commissionsforsalesstaff Creditcardfeesoncustomerpurchases Equipment,perhapsincludingusage-baseddepreciation Utilitiesfortheproductionsite Shipping Asgenerallydefined,grossprofitdoesnotincludefixedcosts(thatis,coststhatmustbepaidregardlessofthelevelofoutput).Fixedcostsincluderent,advertising,insurance,salariesforemployeesnotdirectlyinvolvedintheproduction, andofficesupplies. However,itshouldbenotedthataportionofthefixedcostisassignedtoeachunitofproductionunderabsorptioncosting,whichisrequiredforexternalreportingunderthegenerallyacceptedaccountingprinciples(GAAP). Forexample,ifafactoryproduces10,000widgetsinagivenperiod,andthecompanypays$30,000inrentforthebuilding,acostof$3wouldbeattributedtoeachwidgetunderabsorptioncosting. Grossprofitshouldn'tbeconfusedwith operatingprofit.Operatingprofitiscalculatedbysubtractingoperatingexpensesfromgrossprofit. Acompany'sgrossprofitwillvarydependingonwhetheritusesabsorptioncosting(requiredforexternalreporting)orvariablecosting(disallowedforexternalreportingbutusefulforinternalreporting). GrossProfitvs.GrossProfitMargin Grossprofitcanbeusedtocalculateanothermetric,thegrossprofitmargin.Thismetricisusefulforcomparingacompany'sproductionefficiencyovertime.Simplycomparinggrossprofitsfromyeartoyearorquartertoquartercanbemisleading,sincegrossprofitscanrisewhilegrossmarginsfall—aworryingtrendthatcouldlandacompanyinhotwater. Althoughthetermsaresimilar(andsometimesusedinterchangeably),grossprofitisnotthesameasgrossprofitmargin.Grossprofitisexpressedasacurrencyvalue,grossprofitmarginasapercentage. Theformulaforgrossprofitmarginisasfollows: Gross Profit Margin = Revenue − CoGS Revenue where: CoGS = Cost of Goods Sold \begin{aligned}&\text{GrossProfitMargin}=\frac{\text{Revenue}-\text{CoGS}}{\text{Revenue}}\\&\textbf{where:}\\&\text{CoGS}=\text{CostofGoodsSold}\end{aligned} ​Gross Profit Margin=RevenueRevenue−CoGS​where:CoGS=Cost of Goods Sold​ GrossProfitvs.NetIncome Grossprofitisdifferentfromnetprofit,alsoreferredtoasnetincome.Thoughbothareindicatorsofacompany'sfinancialabilitytogeneratesalesandprofit,thesetwomeasurementshaveentirelydifferentpurposes. Grossprofitiscalculatedbysubtractingcostofgoodssoldfromnetrevenue.Then,bysubtractingremainingoperatingexpensesofthecompany,youarriveatnetincome.Netincomeistheprofitearnedbyabusinessafterallexpenseshavebeenconsidered,whilegrossprofitonlyconsidersproduct-specificcostsofthatgoodsthathavebeensold. Becausethesearetwodifferentcalculations,theyhaveentirelydifferentpurposesforgauginghowacompanyisdoing.Grossprofitisusefultodeterminehowwellacompanyismanagingitsproduction,laborcosts,rawmaterialsourcing,andspoilageduetomanufacturing.Netincomeisusefultodetermineoverallwhetheracompany'senterprise-wideoperationmakesmoneywhenfactoringinadministrativecosts,rent,insurance,andtaxes. Netincomeisoftenreferredtoas"thebottomline"becauseitresidesattheendofanincomestatement.Alternatively,grossprofitisoftenthethirdlinetothetoponanincomestatement(underneathnetrevenueandcostofgoodssold). HowtoCalculateGrossProfit Hereisanexampleofhowtocalculategrossprofitandthegrossprofitmargin,usingCompanyABC'sincomestatement. Revenues (inUSDmillions) Automotive 141,546 Financialservices 10,253 Other 1    Totalrevenues 151,800 Costsandexpenses   Automotivecostofsales 126,584 Selling,administrative,andotherexpenses 12,196 FinancialServicesinterest,operating,andotherexpenses 8,904    Totalcostsandexpenses 147,684 Tocalculatethegrossprofit,wefirstaddup thecostofgoodssold(COGS),whichsumsupto$126,584.Wedonotincludeselling,administrativeandotherexpensessincethesearemostlyfixedcosts.Wethensubtractthecostofgoodssoldfromrevenuestoobtainagrossprofitof$151,800-$126,584=$25,216million. Toobtainthegrossprofitmargin,wedividethegrossprofitbytotalrevenuesforamarginof$25,216/$151,800=16.61%.Thiscomparesfavorablytoanautomotiveindustryaverageofaround14%,suggestingthatFordoperatesmoreefficientlythanitspeers. AdvantagesofUsingGrossProfit There'safewreasonswhyacompanywouldwanttoanalyzegrossprofitasopposedtonetprofit.Grossprofitisolatesperformanceoftheproductorserviceitisselling.Bystrippingawaythe"noise"ofadministrativeoroperatingcosts,acompanycanhoneinstrategicallythinkingabouthowitsproductsareperformingoremploygreatercostcontrolstrategies. Grossprofitisalsogenerallymorecontrollablethanotheraspectsofacompany.Considercostssuchasutilities(forofficeoperations),rent,insurance,orsuppliesSomeofthoseexpensesareunavoidableduringthecourseofbusinessandrelativelyuncontrollableinregardstotheexpensesincurred Ontheotherhand,grossprofitisdictatedbynetrevenue(largelydrivenbythepricesetbyacompany)andcostofgoodssold(largelydrivenbytheinputsacompanypaysforitsproduct).Acompanycanstrategicallyaltermorecomponentsofgrossprofitthanitcannetprofit;therefore,thereisvalueinsometimeslimitingmanagement'sviewtoprimarilywhatitcancontrol. LimitationsofUsingGrossProfit Standardizedincomestatementspreparedbyfinancialdataservicesmaygiveslightlydifferentgrossprofits.Thesestatementsconvenientlydisplaygrossprofitsasaseparatelineitem,buttheyareonlyavailableforpubliccompanies. Investorsreviewingprivatecompanies'incomeshouldfamiliarizethemselveswiththecostandexpenseitemsonanon-standardizedbalancesheetthatmayormaynotfactorintogrossprofitcalculations. Atahighlevel,grossprofitisuseful;however,acompanywilloftenneedtodigdeepertobetterunderstandwhyitisunderperforming.Forexample,imagineacompanydiscoversitsgrossprofitis25%lowerthanitscompetitor.Whilegrossprofitisusefulinidentifyinganissue,thecompanymustnowinvestigateallrevenuestreamsandeachcomponentofcostofgoodssoldtotrulyunderstandwhyitsperformanceislacking. Grossprofitcanalsobeamisnomer,especiallywhenconsidertheprofitabilityofservicesectorcompanies.Consideralawofficewithnocostofgoodssold.Inthisexample,thelawoffice'sgrossprofitisequaltoitsrevenue.However,therentexpenseofthecompanyofficeistwiceashighasmonthlyrent.Grossprofitmayindicateacompanyisperformingexceptionallywell,butbemindfulofthe"belowtheline"costswhenanalyzinggrossprofit. WhatDoesGrossProfitMeasure? Grossprofit,alsoknownasgrossincome,equalsacompany’srevenuesminusitscostofgoodssold(COGS).Itistypicallyusedtoevaluatehowefficientlyacompanyismanaginglaborandsuppliesinproduction.Generallyspeaking,grossprofitwillconsidervariablecosts,whichfluctuatecomparedtoproductionoutput.Thesecostsmayincludelabor,shipping,andmaterials,amongothers. WhatIsanExampleofGrossProfit? Considerthefollowingquarterlyincomestatementwhereacompanyhas$100,000inrevenuesand$75,000incostofgoodssold.Importantly,underexpenses,yourcalculationwouldnotincludeanyselling,general,andadministrative(SG&A)expenses.Toarriveatthegrossprofittotal,the$100,000inrevenueswouldsubtract$75,000incostofgoodssoldtoequal$25,000. WhatIstheDifferenceBetweenGrossProfitandNetProfit? Grossprofitistheincomethatisleftafterproductioncostshavebeensubtractedfromrevenue,andhelpsinvestorsdeterminehowmuchprofitacompanyearnsfromtheproductionandsaleofitsproducts.Bycomparison,netprofit,ornetincome,istheprofitthatisleftafterallexpensesandcostshavebeenremovedfromrevenue.Ithelpsdemonstrateacompany'soverall profitability,whichreflectsontheeffectivenessofacompany'smanagement. HowDoYouCalculateGrossProfit? Grossprofitisthedifferencebetweennetrevenueandthecostofgoodssold.Totalrevenueisincomefromallsaleswhileconsideringcustomerreturnsanddiscounts.Costofgoodssoldistheallocationofexpensesrequiredtoproducethegoodorserviceforsale. TheBottomLine Bysubtractingitscostofgoodssoldfromitsnetrevenue,acompanycangaugehowwellitismanagingtheproduct-specificaspectofitsbusiness.Thiscalculationofgrossprofithelpsdeterminewhetherproductsarebeingpricedappropriately,whetherrawmaterialsarebeinginefficientlyused,orwhetherlaborcostsaretoohigh.Ingeneral,grossprofithelpsacompanyanalyzehowitisperformingwithoutincludingadministrativeoroperatingcosts. RelatedTerms GrossMarginDefinition Thegrossmarginrepresentstheamountoftotalsalesrevenuethatthecompanyretainsafterincurringthedirectcosts(COGS)associatedwithproducingthegoodsandservicessoldbythecompany. more WhatIsMyGrossIncome? Grossincomerepresentsthetotalincomefromallsources,includingreturns,discounts,andallowances,beforedeductinganyexpensesortaxes. more UnderstandingProfit Profitisbenefitrealizedwhentheamountofrevenuegainedfromanactivityexceedstheexpenses,costs,andtaxesneededtosustaintheactivity. more WhatIsOperatingIncome? Operatingincomelooksatprofitafterdeductingoperatingexpensessuchaswages,depreciation,andcostofgoodssold. more EarningsBeforeInterestandTaxes(EBIT):DefinitionandFormula Earningsbeforeinterestandtaxes(EBIT)isanindicatorofacompany'sprofitabilityandiscalculatedasrevenueminusexpenses,excludingtaxesandinterest. more CommonSizeIncomeStatementDefinition Acommonsizeincomestatementisanincomestatementinwhicheachlineitemisexpressedasapercentageofthevalueofsales,tomakeanalysiseasier. more PartnerLinks RelatedArticles FinancialStatements GrossProfitvs.NetIncome:What'stheDifference? Tools HowDoGrossProfitandGrossMarginDiffer? CorporateFinance HowFixedandVariableCostsAffectGrossProfit FinancialStatements OperatingIncomevs.GrossProfit FinancialAnalysis AbsorptionCostingvs.VariableCosting:What'stheDifference? Tools HowDoGrossProfitandEBITDADiffer?