Gross profit is a performance metric used in financial accounting that provides insight into a business’s profitability. From small family-owned businesses to Fortune 500 companies, all businesses should calculate their gross profit. Doing so can help entrepreneurs and business owners optimize their operations for higher profits. In this post, you’ll learn more about gross profit, including what it means and how it’s calculated.
What Is Gross Profit?
Also known as gross income, gross profit refers to the profit generated by a business during a specific time frame. In other words, it’s the revenue a business generates minus certain expenses. Gross profit specifically takes into account the business’s cost of goods sold (COGS) during the given time frame.
How to Calculate Gross Profit
As a business owner, you can calculate your organization’s gross profit by subtracting COGS from your revenue. If you want to calculate your business’s gross profit from 2018, for example, take your business’s total revenue from 2018 and subtract it by your business’s COGS.
COGS includes all variable expenses that can either increase or decrease depending on your business’s operations. If an expense is directly associated with your business’s operations — and it can fluctuate depending on your business’s level of output — it’s considered a variable expense and, thus, used in the gross profit formula. Common examples of variable expenses classified as COGS include the following:
- Credit card transaction fees
- Packaging supplies
- Sales commissions
Let’s say your business generated $1 million in revenue in 2018 and its COGS for that year was $200,000. Using the aforementioned formula, your business’s gross profit for 2018 would be $800,000. You subtract $200,000, which is your business’s COGS, from $1 million, which is your business’s revenue, resulting in a 2018 gross profit of $800,000. As you can see, calculating gross profit is relatively simple and straightforward. If you know your business’s revenue and COGS, you can calculate its gross profit.
Gross Profit vs Net Profit: What’s the Difference?
Gross profit is often confused with net profit, but they aren’t necessarily the same. Net profit is calculated by taking your business’s revenue and subtracting it by all your business’s expenses, whereas gross profit is calculated by taking your business’s revenue and subtracting it by your business’s COGS. Regardless of the market or industry in which your business operates, it will probably incur expenses besides COGS. Net profit takes into account all your business’s expenses, whereas gross profit only takes into account your business’s COGS.
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