What Is Gross Profit? (Definition and Calculation Examples)

By Indeed Editorial Team

Published May 9, 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

When you evaluate a company's overall finances, you may find it beneficial to calculate gross profit. This value can help you get a comprehensive overview of company finances. Learning more about how to calculate gross profit can help you determine how much profit a business earns after producing and selling its goods or services and help you make more informed business decisions.

In this article, we define gross profit, explain its importance, review how to calculate it, provide tips to help improve overall gross profit, define gross profit margin with some tips to improve it, and explore examples of calculating both gross profit and gross profit margin.

What is gross profit?

If you're considering a career in corporate finance, you may wonder, "What is gross profit?" Gross profit is the income a company generates after deducting the production costs of its goods and services. It's part of the company's financial statement and shows its financial health. This measure may also assess a company's efficiency at using its labour and supplies to produce quality goods and services.

Importance of calculating gross profit

Calculating gross profit can help you assess profitability ratios, which may demonstrate how well the company utilizes its assets to generate profit and ensure value for its shareholders. Product pricing may also affect gross profit, as the price you set can affect the profit margin per unit sold. For instance, higher prices may allow the company to gain more profit.

Gross profit information can also help you make decisions based on data of company performance. For instance, a high gross profit may justify hiring more employees. A low gross profit can mean that the company requires changes such as better pricing and reduced expenditure in non-critical areas.

Related: Profitability vs. Revenue: Understanding the Difference

How to calculate gross profit

Here's a list of steps you can take to calculate gross profit:

1. Get the company's financial statement

You can ask the company's accountant for financial information, including details about the company's financial statement. Financial statements may give you information about cash flow, income, or changes in equity. The statement may have crucial information to inform any decisions regarding the business.

2. Calculate total earnings

Assessing the total revenue from sales may require you to add the value of all credit and cash sales within a specific period. The value of each item that the company has sold is typically available on the inventory records. To calculate the total earnings, you can take the number of units the company sold, then multiply by the average price of each item.

Read more: How to Calculate Net Income for an Individual and a Business Organization

3. Determine the cost of goods sold and use the gross profit formula

Cost of goods sold refers to the price the company paid to produce various goods or services, including labour and materials. For instance, if a company processes apples, the cost of goods sold may include costs associated with planting, harvesting, fertilizer and pesticides, and labour. You can then subtract the cost of goods sold from the revenue to calculate the gross profit. The gross profit formula is:

Gross profit = total revenue - the cost of goods sold

Related: How to Calculate Gross Profit Percentage (With Tips)

Tips to help you improve gross profit

Here's a list of tips you can use to increase a company's gross profit:

  • Understand the formula: Understanding the gross profit formula can help you visualize data, make calculations, and solve problems when balancing finances. This may also allow you to use your resources to optimize profits efficiently.

  • Measure the margin ratio: This may require you to compare figures with other companies to understand where you can improve your operations. Doing this can also help provide insight into the pricing of your products and services.

  • Survey the market for alternative options: You can search the industry for low-price suppliers, cheaper raw materials, or labour-saving technology to lower the cost of goods sold.

What is the gross profit margin?

Gross profit margin can be an essential component of gross profit calculations and can help provide a complete view of company finances. The gross profit margin shows all the company's profit after deducting selling costs, general costs, and administrative costs. Here's how you can calculate gross profit margin:

  • Determine the total revenue amount: The total revenue includes all the income from sales, royalties, interest, rental properties, and any other activities of the business. You can calculate the total revenue by multiplying the average price of each item by the number of items sold.

  • Calculate your cost of goods sold and deduct the revenue: The cost of goods sold refers to the cost of all the processes the company performed to get the product to the market. Once you deduct the cost of goods sold from the revenue, the resulting value is the gross profit.

  • Divide the gross profit by the total revenue and multiply by 100%: The result you obtain after dividing the gross profit by revenue is the gross profit margin. You can then multiply it by 100 to express the value as a percentage.

Here's the formula for calculating gross profit margin:

Gross profit margin = [(revenue - cost of goods sold) / revenue] x 100%

Importance of calculating gross profit margin

Calculating gross profit margin can help company stakeholders make accurate and efficient financial decisions. It can also show whether a company's sales are enough to cover its costs and still have a significant profit. A higher margin may also show how close the company is to a higher operating profit.

Related: What Is Economic Profit? (With Steps to Calculate It)

Tips to help you increase gross profit margin

Here's a list of strategies you may use to increase a company's gross profit margin:

  • Lower the cost of goods: If the company gains goods in bulk, you may negotiate with the seller to get a discount. You can also purchase products during special holidays when sellers are more likely to give consumers discounts.

  • Automate systems: Investing in software and new technology can help companies reduce labour costs. Such systems can also allow for better efficiency, which may increase gross profit, influencing the gross profit margin.

Related: How to Calculate Net Profit Margin (With Examples)

Gross profit calculation examples

Here are a few examples of how to calculate gross profit:

Example calculating gross profit for a bakery

Here's an example of calculating gross profit for a bakery:

Rolly's Bakery has a revenue of $50,000, and its cost of goods sold totals $30,000. Here's the formula you can use to calculate the gross profit for the business:

Total revenue - cost of goods sold = gross profit

$50,000 - $30,000 = $20,000

The gross profit for Rolly's Bakery is $20,000.

Example calculating gross profit for a resort and spa

Here's an example of a gross profit calculation for a resort and spa for your consideration:

Jupiter Resort and Spa have had net sales of $60,000 during the fiscal year, with a total cost of goods sold value equalling $20,000. Their gross profit is:

Total revenue - cost of goods sold = gross profit

$60,0000 - $20,000 = $40,000

The gross profit for Jupiter Resort and Spa is $40,000.

Example calculating gross profit for a salon

You can review this example of calculating gross profit to help you make your own calculations:

Ricky's Salon has accumulated a revenue of $100,000 during the current accounting period, with a total cost of goods of $40,000. Here's the formula to calculate gross profit:

Total revenue - cost of goods sold = gross profit

$100,000 - $40,000 = $60,000

The gross profit for Ricky's Salon is $60,000.

Gross profit margin calculation examples

Here are some examples to help you understand how to use the formula to calculate gross profit margin:

Example calculating gross profit margin for a flower shop

You can review this example of calculating the gross profit margin for a flower shop to help you make your own calculations:

Regal Flower Shop sells bouquets for $50. The cost of planting, preparing, and maintaining a bouquet is $15. Here's the formula to calculate the gross profit margin:

[(Revenue – cost of goods sold) / revenue] x 100 = gross profit margin

((50 - 15) / 50) x 100

(35 / 50) x 100

0.7 x 100 = 70%

Example calculating gross profit margin for a restaurant and deli

Here's an example of calculating gross profit margin for a restaurant and deli:

At Pablo's Pizza and Deli, the average restaurant food price is $500. To buy ingredients and prepare the food, Pablo spends $100. Here's the calculation for the gross profit margin:

[(Revenue – cost of goods sold) / revenue] x 100 = gross profit margin

((500 - 100) / 500) x 100

(400/500) x 100

0.8 x 100 = 80%

Example calculating gross profit margin for a computer store

Here's an example of calculating the gross profit margin for a computer store for your review:

Rubi Computers reported a sales revenue of $200 million, and the cost of goods sold is $100 million. Here's the formula to calculate the gross profit margin:

[(Revenue – cost of goods sold) / revenue] x 100 = gross profit margin

((200 - 100) / 200) x 100

(100 / 200) x 100

0.5 x 100 = 50%

Explore more articles