Gross Profit

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Gross Profit

Gross profit is a company’s revenue minus the direct costs of producing the goods or services sold (cost of goods sold, or COGS). It shows how much money a company earns from its core production activities before accounting for operating expenses, taxes, interest, and other non-production costs.

Key formulae

  • Gross profit = Revenue (Net sales) − Cost of goods sold (COGS)
  • Gross profit margin (%) = (Revenue − COGS) ÷ Revenue × 100

What COGS includes

COGS covers the direct, variable costs tied to production, such as:
* Raw materials and components
* Direct labor tied to production
* Production-site utilities and usage-based depreciation
* Shipping and handling for sold goods
* Sales commissions and credit-card fees (when tied to sales)
* Other costs that vary with production volume

COGS generally excludes fixed operating costs such as rent, administrative salaries, insurance, and most marketing expenses.

Calculating gross profit

  1. Start with total revenue (net sales after returns and discounts).
  2. Subtract COGS (direct production costs) to get gross profit.
  3. Divide gross profit by revenue to get gross profit margin.

Note on costing methods:
* Absorption costing allocates both variable and fixed production costs to COGS (required for external GAAP reporting). This can reduce reported gross profit.
* Variable (direct) costing assigns only variable production costs to COGS, leaving fixed production costs below the gross profit line. The chosen method affects comparability and reported gross profit.

Example allocation: If factory rent is $30,000 and 10,000 units are produced, $3 of rent per unit would be included in COGS under absorption costing.

Gross profit vs. gross profit margin

  • Gross profit is an absolute dollar amount (e.g., $25,000).
  • Gross profit margin is a percentage showing profit per dollar of sales (e.g., 25%).
    Compare margins rather than raw gross-profit dollars when assessing production efficiency or comparing across periods and companies.

Gross profit vs. net income

  • Gross profit measures product-level profitability (revenue less COGS).
  • Net income (net profit) is the “bottom line” after subtracting operating expenses, interest, taxes, and one-time items from gross profit.
    Gross profit helps evaluate production efficiency; net income assesses overall profitability and management effectiveness.

Examples

  1. Large-company example from financial data:
    Revenue = $151,800 million
    COGS = $126,584 million
    Gross profit = $151,800 − $126,584 = $25,216 million
    Gross profit margin = $25,216 ÷ $151,800 ≈ 16.61%

  2. Simple quarterly example:
    Revenue = $100,000
    COGS = $75,000
    Gross profit = $25,000
    Gross profit margin = 25%

Industry norms vary widely; many businesses fall between 20%–40% gross margin, but acceptable margins depend on the sector.

Advantages of using gross profit

  • Isolates production performance by excluding administrative and operating “noise.”
  • Helps identify whether pricing, sourcing, or production efficiencies need adjustment.
  • More directly controllable through production and pricing decisions than many fixed operating costs.

Limitations and cautions

  • Different accounting or costing methods (absorption vs. variable) affect comparability.
  • Public financial statements standardize presentation; private-company statements may classify costs differently.
  • For service businesses with little or no COGS, gross profit can be misleading—other operating costs may dominate profitability.
  • A high gross profit does not guarantee overall profitability; operating expenses, taxes, and interest can still produce a net loss.

Quick FAQs

Bottom line

Gross profit is a core metric for assessing how well a company manages the costs directly associated with producing its goods or services. Use gross profit and gross profit margin to evaluate production efficiency, pricing strategy, and cost control—but always consider accounting methods and follow up with deeper analysis of COGS components and operating expenses to understand overall profitability.