What is gross profit

Gross profit, operating profit, and net income refer to the earnings that a company generates. However, each one represents profit at different phases of the production and earnings process. Gross profit is a company's profits earned after subtracting the costs of producing and selling its products—called the cost of goods sold COGS.

Gross profit provides insight into how efficient a company is at managing its production costs, such as labor and supplies, to produce income from the sale of its goods and services. The gross profit for a company is calculated by subtracting the cost of goods sold for the accounting period from its total revenue. Revenue is the total amount of money earned from sales for a particular period, such as one quarter.

Revenue is sometimes listed as net sales because it may include discounts and deductions from returned or damaged merchandise. For example, companies in the retail industry often report net sales as their revenue figure.

The merchandise that has been returned by their customers is subtracted from total revenue. Revenue is often referred to as the "top line" number since it is situated at the top of the income statement. Cost of goods sold refers to the direct costs involved in producing a company's goods. COGS typically includes the following:. We can see from the COGS items listed above that gross profit mainly includes variable costs —or the costs that fluctuate depending on production output.

Typically, gross profit doesn't include fixed costs , which are the costs incurred regardless of the production output. For example, fixed costs might include salaries for the corporate office, rent, and insurance. However, some companies might assign a portion of their fixed costs used in production and report it based on each unit produced—called absorption costing. Gross profit is calculated by subtracting revenue or net sales from a company's cost of goods sold as shown below:. Both gross profit and net income are found on the income statement.

Gross profit is located in the upper portion beneath revenue and cost of goods sold. Net income is found at the bottom of the income statement since it's the result of all expenses and costs being subtracted from revenue. Net income is synonymous with a company's profit for the accounting period.

In other words, net income includes all of the costs and expenses that a company incurred, which are subtracted from revenue. Net income is often referred to as the bottom line due to its positioning at the bottom of the income statement. Although many items can be listed on a company's income statement, depending on the company's industry, usually net income is derived by subtracting the following expenses from revenue:.

Additional income sources are also included in net income. For example, companies often invest their cash in short-term investments, which is considered a form of income. Also, proceeds from the sale of assets are considered income. As stated earlier, net income is the result of subtracting all expenses and costs from revenue, while also adding income from other sources. Depending on the industry, a company could have multiple sources of income besides revenue and various types of expenses.

Some of those income sources or costs could be listed as separate line items on the income statement. For example, a company in the manufacturing industry would likely have COGS listed, while a company in the service industry would not have COGS but instead, their costs might be listed under operating expenses.

The general formula for net income could be expressed as:. A more detailed formula could be expressed as:. Investors often hear the phrase: "A company posted top-line or bottom-line growth. Bottom line growth refers to a growth in net income since net income is listed on the bottom line of the income statement.

Gross profit assesses a company's ability to earn a profit while simultaneously managing its production and labor costs. As a result, it is an important metric in determining why a company's profits are increasing or decreasing by looking at sales, production costs, labor costs, and productivity. If a company reports an increase in revenue, but it's more than offset by an increase in production costs, such as labor, the gross profit will be lower for that period.

For example, if a company hired too few production workers for its busy season, it would lead to more overtime pay for its existing workers. The result would be higher labor costs and an erosion of gross profitability. If the value of net profit is negative, then it is called net loss.

Net profit is another important parameter that determines the financial health of your business. It shows whether the business can make more than what it spends. You can use your net profit to help you decide when and how to work towards expanding your business and when to reduce your expenses. For a business owner, it is important to know the difference between profit and profitability.

Profit is an absolute number which is equal to revenue minus expenses. Profitability, on the other hand, is a relative number a percentage which is equal to the ratio between profit and revenue. Profitability is a measure of efficiency and it is useful in determining the success or failure of a business.

Net profit tells you about the profitability of your business. Knowing about the same has several advantages beneficial for the business. Most government forms and tax forms require you to declare your net profit. Based on your net profit, the financial institutions, like banks, decide whether to issue a loan or not. This stands true because net profit is a common field found on business tax forms. Net profit tells your creditors more about your business health and available cash than gross profit does.

When investors want to invest in your company, they will refer to the net profit of your business to check whether it is worth investing their money. Understanding gross profit trends, on the other hand, can help you find ways to minimize the cost of goods sold or raise your product prices. And if your gross profit is less than your net profit, then you know that you need to find a way to cut down your expenses.

Business encyclopedia. Learn everything there is to know about running a business. The gross profit of a company is the total sales of the firm minus the total cost of the goods sold. The total sales are all the goods sold by the company. The total cost of the goods sold is the sum of all the variable costs involved in sales.

When calculating the total sales figure the business must total all goods sold over the chosen financial time period.

This total cannot include the sale of fixed assets such as a building or equipment. A clothing store, for example, will give the total amount of money generated from the sale of its stock of clothes as the total sales figure. To calculate the costs of goods sold figure, the store must total all costs involved in selling the clothes to customers.

These are variable costs only and are ones that may fluctuate with the level of sales. This will include such costs as:. Personal Finance. Credit Cards. About Us. Who Is the Motley Fool? Fool Podcasts. New Ventures. Search Search:. Updated: Jul 6, at PM. Image source: Getty Images. Join Stock Advisor Discounted offers are only available to new members.