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What Is Gross Profit And How To Calculate It?

IndianMoney.com Research Team | Posted On Monday, February 18,2019, 02:45 PM

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What Is Gross Profit And How To Calculate It?

 

 

What Is Gross Profit? Gross profit is the profit a company makes minus the costs involved in making and selling products, or the costs involved in servicing. Gross profit will be mentioned in a company's income statement and calculated by taking the difference between cost of goods sold (COGS) and revenue/Sales.

Gross profit is the very basic profitability metric as it depicts profit as the revenue that is remaining post accounting for the cost of goods sold (COGS). Cost of goods sold contains those expenses that are directly linked with the production and manufacturing of items for sale, including raw materials and payroll of the labor required to produce the goods.

Gross profit excludes others expenses like cost involved in repaying debt (Interest repayments), taxes, operating and overhead costs and investment in equipment. Gross profit margin compares gross profit with total revenue.

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What Does Gross Profit Indicate?

Gross profit evaluates company’s efficiency in utilizing its labor and supplies for producing goods and / or services. Gross profit considers variable costs that fluctuate with the level of output like:

  • Material
  • Cost of labor
  • Commission for sales and marketing
  • Credit and debit card transaction fee when customers purchase through cards
  • Depreciation of equipments and tools on usage
  • Shipping costs

Gross profit does not include fixed costs that are paid with no regards to the output level. Expenses falling under fixed costs are rent, advertising and marketing, insurance premiums and payroll of employees.

It must be noted that a part of the fixed cost is associated with each unit of production under absorption costing that is required for external reporting under generally accepted accounting principles, GAAP. For example, if a manufacturing unit produces 10,000 utensils over a period of time and the company pays Rs 30,000 towards the rent of the building, a cost of Rs 3 would be attributed to each utensil under absorption costing. 

Gross profit must not be mistaken with operating profit, also referred to as earnings before interest and tax, which is company’s profit before interest and taxes are paid out. Operating profit is calculated by finding the difference between gross profits and operating expenses.

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What Is Gross Profit And How To Calculate It?

Gross Profit Formula

Calculating gross profit is simple and the formula to calculate gross profit is as shown below:

Gross Profit = Sales/Revenue – Cost of Goods Sold.

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Gross Profit Margin Or Gross Profit Percentage

Gross profit margin or gross profit percentage is the difference between revenue and cost of goods sold to revenue. Gross margin is expressed as a percentage of the revenue remaining, post the cost of servicing that revenue. Generally, gross profit margin is calculated as the selling price of an item, minus the cost of goods sold.

Gross profit margin formula:

Gross profit margin = Revenue – Cost of goods sold  

                                                  Revenue

Gross Profit Vs Net Profit

The table shows the major differences between gross profit and net profit:

Gross Profit

Net Profit

It is the excess of net sales above cost of purchase and / or manufacture (all expenses relating to purchase or manufacture of goods) of goods.

It is the excess of gross profit over all indirect expenditures.

It is not true profit of a business

It is true profit of a business.

It shows credit balance of a trading account.

It shows credit balance of profit and loss account.

Progress of a business can be judged by the comparison of gross profit  with net sales

Profitability of a business can be measured by the comparison of net profit with net sales.

Gross profit = Revenue cost – cost of goods sold

Net profit = Gross profit - All indirect expenses

 

How To Increase Gross Profit?

Below mentioned are a few ways in which you can increase gross profit:

1) Increase Prices: Many small business owners feel that if they increase price of products, they would lose out on a large customer base. Hence this is not a favored way of increasing gross profit. However, increasing prices will increase gross profit.

2) Reduce Direct Costs of Goods: You can try and negotiate the amount you pay to the supplier instead of increasing the price of products. This works better as consumers don’t face high prices.

3) Reduce Inventory Waste: You can forecast and plan inventory in a much efficient manner. Many small business owners suffer losses as they lose a sizeable sum of money to wasted inventory. Manage your inventory in a better way, so that you have more products to put on sale.

4) Readjust Your Sales Mix: if you sell a variety of different products and services, then you must find those which offer the highest gross profit margins. Your business may focus on changes because you readjust your business to find the right combination of products that yield higher profits.

5) Integrate New Products or Services: If your business is dealing with only a few products, then you must widen the horizon of your business by adding new products and services. You must be careful while doing this as you would have to invest a certain amount of capital to start off with new products. Make sure that the addition of new products yields better profits.

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Gross Profit Calculations With Example

Consider the following information of a small business:

  • Net Sales - Rs 4,00,000
  • Cost of Goods Sold – Rs 2,80,000

Below is the gross profit calculation:

Gross Profit = (Net Sales – Cost of Goods Sold)

Gross Profit = Rs 4,00,000 – Rs 2,80,000 = Rs 1,20,000.

By gross profit margin formula, we get:

Gross Margin = Gross Profit / Revenue * 100

Gross Margin = Rs 120,000 / Rs 400,000 * 100 = 30%.

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