Gross profit

Definition

Gross profit is a financial metric that represents the revenue a company earns from its core operations minus the direct costs associated with producing or providing the goods or services sold. 

What is gross profit?

This metric provides a measure of the profitability of a company’s primary business activities before accounting for indirect expenses such as operating costs, interest, and taxes.

Gross profit is calculated using the following formula:

Gross profit = revenue – cost of goods sold (COGS)

The gross profit can also be expressed as a percentage, known as gross profit margin. It is calculated using the formula:

Gross profit margin = (gross profit / revenue) x 100%

This provides a standardised measure of profitability, making it easier to compare companies of different sizes and industries.

A higher gross profit indicates that a company is retaining a larger portion of its revenue after accounting for direct production costs. This suggests strong operational efficiency in producing or providing goods and services. On the other hand, a lower gross profit may indicate higher production costs relative to revenue, which can potentially impact overall profitability.

Gross profit does not take into account all expenses, and thus, it provides an incomplete view of a company’s overall profitability.

Example of gross profit

Let’s consider Company ABC, a clothing retailer, for a specific quarter. In this period, the company has the following financial information:

• Total revenue: £800,000
• Cost of goods old (COGS): £400,000

Using the formula, gross profit can be calculated as:

$800,000-\; \pounds 400,000=\; \pounds 400,000$

In this example, Company ABC’s gross profit for the quarter is £400,000. This means that, after accounting for the direct costs associated with producing or purchasing the clothing items sold, the company has £400,000 remaining to cover other operating expenses.