Gross Profit

What Is Gross Profit?

Gross profit is the profit a company makes after deducting the costs associated with making and selling its products, or the costs associated with providing its services. Gross profit will appear on a company's income statement and can be calculated by subtracting the cost of goods sold (COGS) from revenue (sales). These figures can be found on a company's income statement. Gross profit may also be referred to as sales profit or gross income.

Key Takeaways

  • Gross profit, also called gross income, is calculated by subtracting the cost of goods sold from revenue.
  • Generally, gross profit only includes variable costs and does not account for fixed costs.
  • Gross profit assesses a company's efficiency at using its labor and supplies in producing goods or services.

Gross Profit

Formula for Gross Profit

Gross Profit = Revenue Cost of Goods Sold \begin{aligned} &\text{Gross Profit} = \text{Revenue} - \text{Cost of Goods Sold} \\ \end{aligned} Gross Profit=RevenueCost of Goods Sold

What Gross Profit Can Tell You

Gross profit assesses a company's efficiency at using its labor and supplies in producing goods or services. The metric mostly looks at variable costs—that is, costs that fluctuate with the level of output, such as:

  • Materials
  • Direct labor, assuming it is hourly or otherwise dependent on output levels
  • Commissions for sales staff
  • Credit card fees on customer purchases
  • Equipment, perhaps including usage-based depreciation
  • Utilities for the production site
  • Shipping

As generally defined, gross profit does not include fixed costs (that is, costs that must be paid regardless of the level of output). Fixed costs include rent, advertising, insurance, salaries for employees not directly involved in the production, and office supplies.

However, it should be noted that a portion of the fixed cost is assigned to each unit of production under absorption costing, which is required for external reporting under the generally accepted accounting principles (GAAP).

For example, if a factory produces 10,000 widgets in a given period, and the company pays $30,000 in rent for the building, a cost of $3 would be attributed to each widget under absorption costing.

Gross profit shouldn't be confused with operating profit. Operating profit is calculated by subtracting operating expenses from gross profit.

Gross Profit vs. Gross Profit Margin

Gross profit can be used to calculate another metric, the gross profit margin. This metric is useful for comparing a company's production efficiency over time. Simply comparing gross profits from year to year or quarter to quarter can be misleading, since gross profits can rise while gross margins fall—a worrying trend that could land a company in hot water.

Although the terms are similar (and sometimes used interchangeably), gross profit is not the same as gross profit margin. Gross profit is expressed as a currency value, gross profit margin as a percentage. The formula for gross profit margin is as follows:

Gross Margin = Revenue Cost of Goods Sold Revenue \begin{aligned} &\text{Gross Margin} = \frac { \text{Revenue} - \text{Cost of Goods Sold} }{ \text{Revenue} } \\ \end{aligned} Gross Margin=RevenueRevenueCost of Goods Sold

Example of How to Use Gross Profit

Here is an example of how to calculate gross profit and the gross profit margin, using Company ABC's income statement.

Revenues (in USD millions)
Automotive 141,546
Financial services 10,253
Other 1
     Total revenues 151,800
Costs and expenses  
Automotive cost of sales 126,584
Selling, administrative, and other expenses 12,196
Financial Services interest, operating, and other expenses 8,904
     Total costs and expenses 147,684

To calculate the gross profit, we first add up the cost of goods sold (COGS), which sums up to $126,584. We do not include selling, administrative and other expenses since these are mostly fixed costs. We then subtract the cost of goods sold from revenues to obtain a gross profit of $151,800 - $126,584 = $25,216 million.

To obtain the gross profit margin, we divide the gross profit by total revenues for a margin of $25,216 / $151,800 = 16.61%. This compares favorably to an automotive industry average of around 14%, suggesting that Ford operates more efficiently than its peers.

Limitations of Using Gross Profit

Standardized income statements prepared by financial data services may give slightly different gross profits. These statements conveniently display gross profits as a separate line item, but they are only available for public companies.

Investors reviewing private companies' income should familiarize themselves with the cost and expense items on a non-standardized balance sheet that may or may not factor into gross profit calculations.

What Is Gross Profit?

Gross profit, also known as gross income, equals a company’s revenues minus its cost of goods sold (COGS). It is typically used to evaluate how efficiently a company is managing labor and supplies in production. Generally speaking, gross profit will consider variable costs, which fluctuate compared to production output. These costs may include labor, shipping, and materials, among others.

What Is an Example of Gross Profit?

Consider the following quarterly income statement where a company has $100,000 in revenues and $75,000 in cost of goods sold. Importantly, under expenses, your calculation would not include any selling, general, and administrative (SG&A) expenses. To arrive at the gross profit total, the $100,000 in revenues would subtract $75,000 in cost of goods sold to equal $25,000.