Gross profit is the profit a business makes after variable production costs but before fixed costs. It indicates how efficiently a company is using its labour and/or materials. Gross profit is sometimes referred to as gross income, gross revenue or sales profit.
Examples of gross profit
The basic gross profit formula is:
Gross Profit = Revenue - (Cost of Goods Sold + Cost of Revenue)
The term Cost of Goods Sold (COGS) refers to costs directly related to the production of goods. The term Cost of Revenue refers to costs directly related to the production of services. Both COGS and COR tend to vary according to the level of production.
Technically, neither COGS nor COR includes fixed costs not directly related to production. With that said, if a company is using the absorption costing method, a portion of the fixed costs will be assigned to each item produced.
For example, if a company had fixed costs of £10K and produced 10K items, then each item would be assigned £1 fixed costs.
Gross profit vs gross profit margin
The gross profit margin formula is: (Gross Profit / Revenue) * 100
The result of this formula is known as the gross profit margin ratio. This is expressed as a percentage value, whereas the gross profit itself is always expressed as a currency value.
Both gross profit and the gross profit margin are useful for assessing a company’s profitability. Gross profit is, however, only valid for the specific company at the specific time. The gross profit margin can be used to track a company’s performance over time. It can also be used to benchmark a company against its competitors.
Gross profit vs net profit
A company’s net profit (or net income) is its profit after all deductions have been made. In other words, it’s what is left over to be reinvested and/or paid out to the company’s owners. Net profit is always shown last on a company’s profit and loss statement and is often known as the bottom line.
As with gross profit, there is a net profit margin ratio. The formula for this is: (Net Income / Revenue) * 100. Again, the net profit margin ratio is always expressed as a percentage value. The net profit itself is always expressed as a currency value.
Net profit is also a useful indicator of a company’s profitability. It is, however, more easily influenced by factors that are not core to a company’s business. In particular, net profit can be pushed down by taxes and interest on debts. It can also be pushed up by non-core income such as income gained from the one-off sale of an asset.
Gross profit vs operating profit
The formula for calculating operating profit is:
Revenue - Cost of Goods Sold (COGS), Operating Expenses, (OPEX) depreciation and amortisation.
The formula for calculating the operating profit margin is (Operating Income / Revenue) * 100.
It can be useful to look at the operating profit and operating profit margin alongside the gross profit and gross profit margin. The operating profit and operating profit margin show profits after all expenses related to revenue-producing activities but before interest and taxes (and non-core income).
This means that the operating profit and operating profit margin tend to be a fairly accurate reflection of how much it actually costs to run a company’s business.
In particular, the operating profit and operating profit margin take into account sales and marketing costs. These are not directly attributable to the cost of producing goods or services. They can, however, play a huge role in a company’s success.