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.

Understanding Gross Profit

Gross profit assesses a company's efficiency at using its labor and supplies in producing goods or services. The metric mostly considers 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

The formula for gross profit is:

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

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, also known as earnings before interest and tax (EBIT), which is a company's profit before interest and taxes are factored in. 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:

$\begin{aligned} &\text{Gross Margin} = \frac { \text{Revenue} - \text{Cost of Goods Sold} }{ \text{Revenue} } \\ \end{aligned}$​Gross Margin=RevenueRevenue−Cost 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 Ford Motor Co.'s 2018 annual income statement:

To calculate the gross profit, we first add up the cost of goods sold, 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 do and don't factor into gross profit calculations.

Frequently Asked Questions

What is gross profit?

Gross profit, also known as gross income or pre-tax earnings, equals a company’s revenues minus its cost of goods sold. 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 in relation to production output. These costs may include labor, shipping, and materials, among others.

What is the difference between gross profit and net income?

While gross profit refers to subtracting the variable costs, or cost of goods sold from its sales, net income further subtracts interest costs and taxes from company earnings. Net income is sometimes referred to as the “bottom line” since it falls on the last line of a company’s income sheet. It is often used to measure the profitability of a company.

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 the $10,000 fixed costs which fall under selling, administrative, and other 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.