How to Calculate Gross Profit: A Guide for Finance Leaders

What is Gross Profit?

Gross profit is a company’s profit after deducting the costs directly associated with creating and selling its products or services. Also referred to as sales profit or gross income, gross profit analysis allows businesses to evaluate pricing strategies and production cost control—two essential factors for profitability.

Gross profit is always less than total revenue, which measures total sales without factoring in production costs, but greater than net profit, which subtracts operating expenses and taxes from gross profit.

Why Is It Important for Finance Teams to Measure Gross Profit?

Measuring gross profit gives finance teams a clear view of profitability from core operations. By removing direct costs from total sales, businesses can better understand how efficiently they produce goods or services.

Finance teams use gross profit to:

Measure profitability
Assess production efficiency
Monitor changes in processes or market conditions

Tracking gross profit margin over time offers valuable year-on-year performance insights. This data helps finance teams refine pricing strategies, improve cost management, and optimize operational efficiency.

Where Is Gross Profit on the Income Statement?

Gross profit appears near the top of the income statement, right after revenue and cost of goods sold. As a rule, the higher a line item appears, the more critical it is, and gross profit is no exception. Gross profit is expressed as a dollar amount (e.g., $1,000,000) but can also be converted into a percentage to calculate gross profit margin.

What Is the Difference Between Gross Profit and Gross Profit Margin?

Gross Profit: The dollar amount a business retains after subtracting COGS from total revenue.
Gross Profit Margin: A percentage that represents how efficiently a company converts revenue into profit relative to its production costs.

While gross profit reflects the monetary value retained, gross profit margin is a more comparative measure of profitability and efficiency.

What Is Considered a Good Gross Profit?

A higher gross profit typically indicates stronger profitability and operational efficiency, but context matters.

Industry Variation:
- Financial services: Gross profit margins often exceed 80%.
- Manufacturing and distribution: Gross margins of 10%-20% are common due to high production costs.

For most industries, a gross profit margin above 20% is a solid benchmark, but it’s critical to analyze margins within the context of industry norms and company size.

How to Calculate Gross Profit

The formula for gross profit is straightforward:

Gross Profit = Revenue − Cost of Goods Sold (COGS)

For meaningful analysis, finance teams often calculate gross profit over specific periods, such as a quarter or year, to identify trends and assess performance.

Cost of Goods Sold (COGS)

COGS includes all direct costs associated with producing goods or services, such as:

Raw materials
Direct labor costs
Sales commissions
Equipment and maintenance costs
Shipping expenses

COGS excludes indirect costs like marketing, administrative expenses, or financing.

Revenue

Revenue, or net sales, is the total income generated from selling goods or services before expenses are deducted. It accounts for discounts and returns, which is why it’s sometimes referred to as “net sales.”

Revenue Formula:
Units Sold × Price Per Unit

Accurate revenue calculation is essential for determining gross profit and ensuring reliable forecasting and budgeting.

Gross Profit Calculation Example

Let’s consider a real estate company, Urban Estates, developing a set of townhouses:

Calculate Total Revenue
- Urban Estates sold 10 townhomes for $300,000 each.
- Revenue = 10 × $300,000 = $3,000,000
Calculate COGS
- Construction materials: $1,000,000
- Direct labor: $700,000
- Permit and development fees: $200,000
- Utilities and site management: $100,000
- COGS = $2,000,000
Calculate Gross Profit
- Gross Profit = Revenue − COGS = $3,000,000 − $2,000,000 = $1,000,000

This example illustrates how effectively Urban Estates manages construction and material costs.

Advantages and Limitations of Gross Profit

Advantages

Monitors production efficiency: Highlights how well a business controls direct costs.
Informs pricing strategies: Helps determine if pricing adequately covers costs and drives profitability.
Supports cost control: Identifies areas for reducing production expenses.
Useful for comparisons: Allows businesses to evaluate performance across periods or against competitors.

Limitations

Excludes indirect expenses: Does not consider marketing, administrative, or financing costs.
Industry-specific limitations: Less meaningful for service-oriented businesses with significant indirect costs.
Not a full profitability measure: Focuses solely on core operational efficiency.

Automate Your Gross Profit Calculations

Manual gross profit calculations can be time-consuming and prone to error, especially for businesses with complex operations. Finance leaders increasingly rely on PivotXL, an advanced financial planning and analysis platform, to automate revenue and COGS calculations.

With PivotXL, you can: