Gross profit is the amount of revenue after you deduct the cost of goods. In other words, it is the difference between the Sales Revenue and Cost of Goods Sold. It is important to note that you do not subtract the costs associated with running the company, such as salaries and rent, only those that directly relate to the product sold. Nonetheless, each company attributes expenses it incurs to COGS differently.
How Does Gross Profit Work?
Gross Profit is a separate section on the Income Statement. It is considered a preliminary measure of the company’s profitability. The mathematical formula for calculating Gross Profit is Sales Revenue (Income) – Cost of Goods = Gross Profit. The cost of goods is the amount it costs to produce or procure (buy/obtain) a product. For example, you purchased a book for $6 and sold it for $10. The gross profit you made will equal $10 minus $6. Thus, your gross profit is $4.
Why Does Gross Profit Matter?
Gross profit is an important measure of profitability. It indicates the efficiency of the management in using labor and supplies in the production process or management decisions during product procurement. A high gross profit usually means that you are doing a great job and have money to invest back into your company.
If there is a negative change in gross profit, it helps to take necessary actions to prevent negative consequences and find ways to increase your profitability. It is also used to calculate gross margin, another important indicator that allows comparing different companies in the same industry.