DEFINITION of 'Gross Profit'
A company's total revenue (equivalent to total sales) minus the cost of goods sold. 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 or can be calculated with this formula:
Gross profit = revenue - cost of goods sold
Also called "gross margin," "sales profit" and "gross income".
BREAKING DOWN 'Gross Profit'
Gross profit assesses a company's efficiency at using labor and supplies. The metric only considers variable costs, that is, costs that fluctuate with the level of output: 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; etc. As generally defined, gross profit does not include fixed costs, or costs that must be paid regardless of the level of output: rent, advertising, insurance, salaries for employees not directly involved in 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 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, also known as earnings before interest and tax (EBIT).
Gross profit can be used to calculate the gross profit margin. Expressed as a percentage, 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. The terminology here can cause some confusion: "gross margin" can be used to mean either gross profit and gross profit margin. Gross profit is expressed as a currency value, gross profit margin as a percentage. The formula for gross profit margin is:
Gross profit margins vary greatly by industry. Food and beverage stores and construction firms have razor-thin gross profit margins, for example, while the healthcare and banking industries enjoy much larger ones.
Here is an example of how to calculate gross profit and the gross profit margin, using Ford Motor Co.'s (F) 2014 annual income statement (all numbers in millions of USD):
|Costs and expenses|
|Automotive cost of sales||123,516|
|Selling, administrative and other expenses||14,117|
|Financial Services interest expense||2,699|
|Financial Services provision for credit and insurance loss||305|
|Total costs and expenses||140,637|
To calculate the gross profit, we first add up the cost of goods sold:
Automotive cost of sales ($123,516 m) + FS interest expenses ($2,699 m) + FS provision for credit and insurance loss ($305 m) = $126,520 m
We do not include "Selling, administrative and other expenses," since these are mostly fixed costs. We then subtract the cost of goods sold ($126,520 m) from total revenues ($144,077 m) to obtain a gross profit of $17,577 m.
To obtain the gross profit margin, we divide the gross profit ($17,577 m) by total revenues ($144,077) for a margin of 12.20%. This compares unfavorably to an automotive industry average of around 20%, suggesting that Ford does not operate as efficiently as its peers.
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 do and don't factor into gross profit calculations.
For more on gross profit, see Understanding Profit Metrics: Gross, Operating and Net Profits.
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