Calculate Gross Profit and Gross Profit Margin
Formula for Gross Profit
The formula for gross profit is:
- Gross Profit = Revenue – Cost of Goods Sold
- Revenue is equal to net sales, or total sales less returns, discounts, and rebates.
- Cost of goods sold is the variable costs associated with each unit of production.
- Revenue is income earned by a company prior to any expenses. It is known as the “top line”because it’s the top line on an income statement, whereas net profit is referred to as the “bottom line”because it is the bottom line on an income statement.
The cost of goods sold are the costs incurred necessary to fulfill orders and do not include fixed costs, which are costs that will be incurred regardless of whether a unit is produced.
Examples of expenses included in the cost of goods sold are:
- Hourly labor
- Materials for production
- Equipment used in production
- Sales commissions
- Transaction fees
- Shipping and fulfillment
Formula for Gross Profit Margin
Gross profit is used to calculate gross profit margin. The gross profit margin formula is:
- Gross Profit Margin = Gross Profit / Revenue
Gross profit margin (or just “gross margin” ) is gross profit as a percentage of a company’s revenue.
Implications of Gross Profit Margin
Since the cost of producing goods is an inevitable expense, some investors view gross margin as a measure of a company’s overall ability to generate profit.
The margin remaining after subtracting the cost of goods sold is used to pay for all other expenses, and if the company is profitable, the money left over is known as “net profit.”