What Is Gross Profit and How Is It Calculated?
Written by True Tamplin, BSc, CEPF®
Updated on May 6, 2022
Define Gross Profit in Simple Terms
Gross Profit is a “Profitability Ratio”used by investors, analysts, and company management to show how efficiently a company produces an item.
It monitors the manufacturing process by subtracting the cost of production, also known as Cost of Goods Sold, from revenue.
A higher gross profit indicates that the company is becoming more efficient in producing the product or is selling products for higher prices.
Gross Profit Formula
The Gross Profit Formula is:
- Gross Profit = Revenue – Cost of Goods Sold
Revenue is sales; the price paid by customers for goods or services.
Cost of Goods Sold is an accounting term that includes all costs of acquiring, manufacturing or otherwise producing an item.
This includes raw materials, labor, manufacturing overhead and shipping costs; every cost up until the product is ready for sale.
Gross Profit has limited value though because the resulting amount is not scaled to be easily compared to other products or companies.
A computer will have a higher Gross Profit than a calculator, even if the calculator is produced more efficiently, because it is sold at a higher price.
Define Gross Profit in Simple Terms
Gross Profit is a “Profitability Ratio”used by investors, analysts, and company management to show how efficiently a company produces an item.
It monitors the manufacturing process by subtracting the cost of production, also known as Cost of Goods Sold, from revenue.
A higher gross profit indicates that the company is becoming more efficient in producing the product or is selling products for higher prices.
Gross Profit Formula
The Gross Profit Formula is:
- Gross Profit = Revenue – Cost of Goods Sold
Revenue is sales; the price paid by customers for goods or services.
Cost of Goods Sold is an accounting term that includes all costs of acquiring, manufacturing or otherwise producing an item.
This includes raw materials, labor, manufacturing overhead and shipping costs; every cost up until the product is ready for sale.
Gross Profit has limited value though because the resulting amount is not scaled to be easily compared to other products or companies.
A computer will have a higher Gross Profit than a calculator, even if the calculator is produced more efficiently, because it is sold at a higher price.
Gross Profit vs Gross Profit Margin
Instead, Gross Profit Margin is more often used.
It takes gross profit and divides it by revenue to return the percentage of gross profit for each dollar of revenue. This scaling makes comparisons easier.
Gross Profit Margin can be used to compare products, companies, or even entire industries.
Companies with a higher Gross Profit Margin will be more attractive to investors because they are better at the core operations of the business, producing a product.
Demonstrating this, many popular management philosophies such as Just-In-time Manufacturing, Total Quality Management and Six-Sigma all rely on Gross Profit Margin as a way to show their success.
Gross Profit Definition FAQs
Disclaimer: The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.