How to Calculate Gross Profit

Understanding and monitoring your profit is essential to any business, helping to identify areas of growth, aiding decision-making, and contributing to business agility. But how does gross profit differ from net profit, what is a good profit margin, and how do you calculate it? 

How to calculate gross profit?

Gross profit is the difference between net sales revenue and the cost of goods sold (COGS).

Revenue is simply the total amount of income your company generates from the sale of your products or services.

Cost of Goods Sold refers to all the direct costs and expenses involved in producing or delivering your goods and services. This could include raw materials, shipping costs, production equipment, direct labour costs, storage, etc. Note that COGS only includes variable costs, not fixed costs such as salaries, rent, etc.

So, using the formula Gross Profit = Revenue - Cost of Goods Sold, if a business has revenues of £800,000 and calculates the cost of goods sold to be £550,000, it has a gross profit of £250,000.

What is Gross Margin?

Gross margin is calculated by dividing the gross profit into the net revenue. It is expressed as a percentage, and is a useful way to determine how efficiently a company generates gross profit from the sale of products or services.

The gross profit margin formula, Gross Profit Margin = (Revenue – Cost of Goods Sold) / Revenue x 100, shows the percentage ratio of revenue you keep for each sale after all costs are deducted.

So, using the example above, the gross margin is 250,000 / 800,000 x 100, which equates to 31.25%.

You can read more in our guide to calculating gross margin.

Why is gross profit important?

Simply put, gross profit is a key indicator of your profitability and shows both how your business is performing financially and how efficiently it’s managing the variable costs related to those sales. If your profitability fluctuates or declines, your gross profit margin can help you determine why. For example, suppose that your gross margin declines in a year - it may be an indication that the raw material costs from your supplier have increased recently. If sales decline or falter, it may be because the product price is no longer competitive.

Gross profit vs net profit 

While gross profit is the amount you made over a specific time minus COGS, net profit represents your total revenue, minus COGS and all other expenses, including non-operating expenses like taxes or interest as well as rent and marketing.

As net profit considers the cost of all business operations and non-operating expenses, it is a much more realistic representation of your profits. It can be particularly useful if you’re trying to attract investors. It is, however, important to be aware of both figures so that you can fully understand how your business is operating and identify any areas of concern.

What is a "good" gross profit margin? 

Gross margins fluctuate widely across different industries, sectors and even countries, so comparisons are difficult. Consider the example of a consultant who has relatively few overheads compared to a manufacturer who needs a significant amount of raw materials. The consultant will likely have a higher gross profit margin, but this doesn’t necessarily mean one business is better than the other.

How to increase gross profit

There are 3 main routes to increasing your gross profits:

1. Increase your prices

All things being equal, an increase in your prices will result in increased revenue, and the gross profit will therefore increase as well. However, the risk with increasing your prices of course, is that any price increase will typically lead to a decrease in sales, so this needs to be considered carefully.

2. Increase your sales volume

The other option would be to keep your prices the same but attempt to increase sales. This could be particularly effective in areas such as manufacturing, where the fixed cost per unit falls as production volumes increase. This may incur additional costs such as advertising or extra resources that will need to be accounted for.

3. Reduce cost of goods

Finally, you could attempt to reduce the costs of goods sold by sourcing more cost-effective suppliers and cheaper raw materials, investing in technology to automate tasks, or even consider outsourcing.