A lot of business owners and investors lack a proper understanding of gross profit, which affects their ability to evaluate the financial health of their company. We are going to provide you with a clear image of what is gross profit along with practical tips and actionable examples. You will also learn how to calculate gross profit.

What is Gross Profit?

Gross profit is the revenue that is earned by a company after covering all the costs of producing and selling products and providing services. It is like the money you earn from selling lemonade after spending on sugar, lemon, and glasses.

The gross profit of a company is written in the financial statement of a company. You can calculate the gross profit by subtracting the cost to produce a product from the income you gain from selling it. Gross profit is a bit different from operating profit, which may include expenses like rent and employee salaries.

How Gross Profit work?

Gross profit is the money deducted from the total revenue of a sale. It helps the investors and lenders to determine how profitable and efficient a company is. They evaluate the use of labor and supplies for making goods or offering services to customers. Gross profit helps in calculating the cost needed to generate profit from a business.

The cost of goods sold (COGS) is inversely proportional to the value of profit. It means if the cost of goods sold is greater, than the profit will be less. However, if the cost of goods sold is lower, then the revenue will be greater. When the businessman generates more profit, he will have more money to invest in his business.

How to Calculate Gross Profit?

Formula to calculate gross profit

Gross Profit = Total Revenue - Total COGS

Where

• Total revenue is the total earnings after selling the product.
• COGS is a cost of goods sold.

Example

A bakery sells cupcakes with ingredients like dough, icing, toppings and add-ons, and coffee beans. They also need paper bags, cups, lids and napkins. They also have to pay salaries to their staff, and a processing fee is also charged.

Let's assume the total cost of cupcake ingredients, staff wages, and processing fee for purchasing is 129,835. Let's assume the total revenue that the bakery generated is 209,060

To calculate the gross profit of this bakery, we can use the gross profit formula.

Gross Profit = Total Revenue - Total COGS

Gross Profit = 79,225

Why is Gross Profit Important?

Calculating gross profit is very easy, but understanding the purpose of calculating a gross profit matters a lot in a successful business. It is very important in business accounting because it allows us to measure the efficiency of the company and its services. Businessman will be able to evaluate the company's performance by calculating its gross profit.

If the gross profit is high it means the company is making profitable decisions and the performance is good. However, if the value of gross profit is negative, then it means the company is not making efficient decisions around it cost of goods sold. So, the investor or the businessman will have to rethink their approach to production.

Difference between a High and Low Gross Profit Margin

There are a lot of companies struggling for a high gross profit margin to enable high profitability. It means the company is managing its production and sales costs very efficiently, which results in more profit from each sale.

On the other hand low gross profit margin is a bad sign for a company, which indicates sales costs are too high as compared to its sales revenue. It will affect the overall sustainability and profitability of the company.

What is a Good Gross Profit?

A good gross profit totally depends on various factors like the size of the company and the type of the industry. There are a lot of companies that calculate gross profit margins in order to clearly understand the performance of their business. Percentage of revenue is calculated by gross profit margin which helps in comparing different businesses in an industry.

You can calculate the gross profit by dividing gross profit by the total revenue of the company and then multiplying it by 100 if we calculate the gross profit margin of the bakery shop we have discussed above.

Gross Profit Margin = [Gross Profit] [Total Revenue] X 100

Gross Profit Margin = [$79,225] [$209,060] X 100

Gross Profit Margin = 37.89

The gross profit margin of that bakery shop is around 38%. As the bakery shop is a small business, then the gross profit margin higher than 20% would be considered good. However, the high-end industries expect to have a gross profit margin of 50% or above.

Tips to Increase Gross Profit

A company has to improve its performance in order to generate high profits. These are the ways you can increase your gross profit.

• Try to reduce the operating expenses instead of lowering the sale prices of your products.
• Try to maintain your cost and then increase the sale prices of your products.
• Improve the efficiency and productivity of your products.
• Increase the average order value by relying on your existing or regular customers.

FAQs

How to calculate gross profit?

You can calculate the gross profit of a company or a business by a basic formula: "Gross Profit = Revenue Cost of Goods Sold."

How to calculate COGS for gross profit?

You can calculate COGS by this formula: "Starting inventory + purchases ending inventory = cost of goods sold."

How to calculate gross profit margin?

You can calculate gross profit by dividing gross profit by the total revenue of the company and then multiplying it by 100.

Gross Profit Margin = [Gross Profit] [Total Revenue] X 100

Conclusion

If you are an investor, then you will have to focus on some key financial metrics of a company to make efficient and well-informed decisions. You must be aware of what is gross profit and start reviewing the gross profit of your company. It will tell you how much profitable your company is.