Gross profit and gross margin show the profitability of a company when comparing revenue to the costs involved in production. Both metrics are derived from a company's income statement and share similarities but show profitability in a different way.
- Gross profit describes a company's top line earnings; that is, its revenues less the direct costs of goods sold.
- The gross profit margin then takes that figure and divides it by revenue to get a handle on how much gross profit is generated on a percentage basis after taking costs into account.
- Both of these differ from net profit or net profit margin in that net deducts several other indirect costs and expenses not found in the gross profit.
Gross profit refers to the money a company earns after subtracting the costs associated with producing and selling its products. Gross profit is represented as a whole dollar amount, showing the revenue earned after subtracting the costs of production.
Gross profit is calculated by:
- Net sales is 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 deductions 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 income or the bottom line.
- Cost of goods sold or COGS is the direct costs associated with producing goods. COGS includes both direct labor costs, and any costs of materials used in producing or manufacturing a company's products.
Gross profit measures how well a company generates profit from their labor and direct materials. Some of the costs include:
- Direct materials
- Direct labor
- Equipment costs involved in production
- Utilities for the production facility
- Shipping costs
Example of Gross Profit
As a historical example, let's consider Apple's September 30, 2017 gross profit reported from their consolidated 10-K statement the following:
- Net sales or (total sales or revenue) = $229 billion
- Cost of goods sold (cost of sales) = $141 billion
- Gross profit = $88 billion (or $229B - $141B).
We can see that Apple recorded a total gross profit, after subtracting revenue from COGS of $88 billion for 2017 as listed on their income statement labeled as gross margin. Please note, the gross margin figure of $88 billion is an absolute dollar amount and should not be confused with gross profit margin, which is displayed as a percentage and which we'll address in the next section.
Gross Profit Margin
Gross profit margin shows the percentage of revenue that exceeds a company's costs of goods sold. It illustrates how well a company is generating revenue from the costs involved in producing their products and services. The higher the margin, the more effective the company's management is in generating revenue for each dollar of cost.
Example of Gross Profit Margin
In the earlier example, Apple Inc. (AAPL), reported total sales or revenue of $229 billion and COGS of $141 billion as shown from their consolidated 10K statement above. The gross margin dollar total was $88 billion.
Gross profit margin for Apple in 2017:
- ($229 (revenue) - $141 (COGS)) ÷ $229 = 38%
Apple earned 38 cents in gross profit when compared to their costs of goods sold. If a company's ratio is rising, it means the company is selling its inventory for a higher profit.
The Bottom Line
Gross profit and gross profit margin both provide good indications of a company's profitability based on their sales and costs of goods sold. However, the ratios are not a thorough measure of profitability since they don't include operating expenses, interest, and taxes.
Analysts and investors typically use multiple financial ratios to gauge how a company is performing. It's best to compare the ratios to companies within the same industry and over multiple periods to get a sense of any trends.
For more on determining a company's profitability, please read "What Is the Difference Between Gross Profit Margin and Net Profit Margin?"