Gross profit definition:
Gross profit is the amount of money a business makes after deducting the cost of goods sold from the total revenue. An ideal gross profit margin is 20% or higher.
Gross profit margin is a key financial metric that shows the percentage of revenue a business keeps after accounting for the cost of goods sold (COGS). Gross profit is the amount of money a business makes after deducting COGS from total revenue, while gross profit margin expresses that same figure as a percentage of revenue.
Understanding your gross profit margin helps you evaluate how efficiently your business is producing and selling its goods or services. It can influence decisions around pricing, cost management, and overall financial performance.
Let’s take a closer look at how to calculate gross profit and its impact on your financial reporting.
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Gross profit margin is the percentage of revenue remaining after subtracting the cost of goods sold (COGS).
It is calculated as:
Gross Profit Margin = (Revenue − COGS) / Revenue × 100
A gross profit margin of 20% or higher is generally considered good, though benchmarks vary significantly by industry.
You’ll need to know your total revenue and cost of goods sold before determining your gross profit.
The gross profit formula calculates profit by subtracting the cost of goods sold from revenue:
Gross profit = (Revenue - Cost of goods sold)
Gross profit differs from gross profit margin, which uses the same inputs but expresses the result as a percentage instead of a dollar amount.
You’ll need to know your total revenue and cost of goods sold before determining your gross profit.
Calculating gross profit involves understanding two key figures: sales revenue and cost of goods sold (COGS). These usually come from your financial statements but you can also find them by diving into your earnings, administrative expenses, and business credit card transactions.
Sales revenue is the total income generated from selling your products or services. It’s important to note that sales revenue differs from your company's profits. Profit is the income that is left over after you deduct your COGS. To find your sales revenue, either look at your financial statements or calculate all of your earnings for the term you’re looking at.
The revenue formula looks like:
Revenue = Number of sales x price of service
Don't confuse revenue with gross profit! Revenue is your total sales, while gross profit shows how much remains after production costs.
The cost of goods sold can be a bit more tricky. COGS represents the direct costs associated with producing the goods or services you sell. First, you need to break down all of your costs and determine which category they fall under. Those include:
Finding your cost of goods sold should look like this:
COGS = Beginning inventory + purchases +other costs - ending inventory
To find your gross profit, simply take your sales revenue and subtract your cost of goods sold (COGS). Once you have your gross profit, you can calculate your gross profit margin by dividing gross profit by revenue and multiplying by 100.
The gross profit margin formula is:
Gross Profit Margin = (Gross Profit / Revenue) × 100
To calculate your gross profit margin, follow these steps:
Start by calculating your gross profit using the formula: Gross Profit = Revenue − COGS
Next, determine your total revenue for the same period.
Divide your gross profit by your total revenue to get a decimal value.
Multiply the decimal by 100 to express it as a percentage.
Once you’ve calculated your gross profit margin, you can compare it to industry benchmarks or track it over time to evaluate your business’s financial performance.
To understand the gross profit formula and gross profit margin, meet Sally, the owner of Outdoor Manufacturing. Sally’s business manufactures hiking boots, and her firm just completed its first year of operations.
The sales component of the formula is straightforward (selling price multiplied by the number of boots sold). Outdoor sold $520,000 in boots this year (revenue). However, the firm’s cost of sales component is more complex. The cost of goods sold includes direct costs, like materials and labor used to make the boots, and indirect costs, like factory overhead, which adds up to $420,000 (COGS).
Understanding gross profit will help Sally assess the core profitability of the products after accounting for production costs. This is crucial for making pricing and production decisions.
The sales component of the formula is straightforward (selling price multiplied by the number of boots sold). Outdoor sold $520,000 in boots this year (revenue). However, the firm’s cost of sales component is more complex. The cost of goods sold includes direct costs, like materials and labor used to make the boots, and indirect costs, like factory overhead, which adds up to $420,000 (COGS).
Understanding gross profit will help Sally assess the core profitability of the products after accounting for production costs. This is crucial for making pricing and production decisions.
Using the information in the income statement, we can calculate Outdoor Manufacturing’s gross profit:
$520,000 (Revenue) - $420,000 (COGS) = $100,000
A gross profit margin of 20% or higher is often considered a solid baseline. That means for every $1 of revenue, a business keeps at least $0.20 after accounting for the cost of goods sold (COGS).
However, what qualifies as a “good” gross profit margin depends heavily on your industry. Government and academic sources, including data from the U.S. Census Bureau’s Economic Census and Quarterly Financial Report, show that margins vary widely based on business model and cost structure.
Service-based businesses often see gross profit margins of 50% or more, while retail and wholesale businesses may operate in the 10% to 30% range, reflecting higher costs of goods relative to sales.
Ultimately, the most meaningful benchmark is how your margin compares to similar businesses in your industry and size category. Rather than relying on a single average, government and academic resources—including the Census Bureau’s industry statistics and respected academic datasets such as New York University Stern’s sector benchmarks—recommend using industry-specific margins and financial ratios to evaluate performance.
If gross profit is the money left over after COGS you deduct, what exactly is net profit? And what’s the difference between gross profit vs. net income? Essentially, net profit (also known as net income) considers all associated expenses—think business expenses and taxes—whereas gross profit only accounts for COGS.
A firm can use the gross profit formula to assess its profitability. The caveat is that gross profit disregards some additional expenses the company incurs, like operating costs. Net profit fills in these gaps by accounting for all business expenses.
The net profit formula is:
Net profit = Total revenue - total expenses
Using the example above, the net profit for Outdoor Manufacturing is:
$10,000 = $520,000 - $510,000
Both profit and profitability aim to measure how much profit a company makes. The difference is that profitability is more of a relative measurement, typically expressed in a ratio, whereas profit is an absolute measurement, expressed in a dollar amount.
While you’ll always use the same formula to calculate gross profit, measuring profitability is more fluid, and you can express it in multiple ways.
The difference between gross profit profit and gross margin has everything to do with how profits and margins are expressed. While gross profit margin is expressed as a percentage, gross profit is stated as a dollar amount. A margin calculator gives you both figures at once, so you can see the dollar profit and the percentage side by side.
Gross margin is defined by this formula:
(Total revenue - COGS) / (Total revenue)
For example, the gross profit margin for Outdoor Manufacturing is:
19.2% = ($520,000 - $420,000) / ($520,000)
For every dollar of sales, Outdoor Manufacturing generates about 19 cents of gross profit margin. The gross profit formula helps you identify cost-saving opportunities on a per-product basis.
Operating profit is another term that seems similar to gross profit, but they measure very different things. Gross profit measures a business's profit after deducting COGS, whereas operating profit measures a business's profit after deducting all operating expenses.
Operating profit covers all essential costs associated with day-to-day business operations, which include things like labor and internal tools.
Businesses typically analyze their supply chain profits using gross profit, while operating profit is used to measure the company's overall operations efficiency. Because operating profit uses gross profit to calculate profitability, it’s measured after gross profit is determined.
The operating profit formula is:
Operating profit = Gross profit – Operating expenses
For example, the operating profit for Outdoor Manufacturing is:
$10,000 = $100,000 - $90,000
Gross profit provides a clear picture of a company's profitability from its products or services. Since gross profit only encompasses profit as a percentage of sales revenue, it’s the perfect factor when comparing companies. For example, analyzing gross profit can help identify areas for cost control, such as negotiating better deals with suppliers or optimizing production processes.
That said, gross profit is only one piece of the puzzle. It can be limiting since it only takes into account the profitability from COGS and not additional relevant data, such as rising material costs or labor shortages. For example, a low gross profit in a service company with minimal cost of goods sold might not necessarily indicate poor performance.
Instead, companies may need to analyze trends in gross profit over time and consider other profitability metrics, such as operating profit and net profit, to assess their overall financial health.
A company’s gross profit is not just for reflecting on the profitability of a company—you can also use it to increase profits. To improve gross profit, focus on the components of the formula, including total revenue and the cost of goods and labor.
When you build a budget, knowing what gross profit is can reduce costs and increase revenue in the planning process. But finding gross profit can be tricky, especially when you’re strapped for time. That’s where accounting software comes in.
Accounting software can help easily generate your firm’s gross profit, plus other important financial reporting metrics, like operating expenses and net income, to get a clear picture of your business’s overall financial health. You can even compare your firm’s gross profit to other companies in your industry to stay ahead of the curve. Take a proactive approach to your profitability with QuickBooks Online.
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