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Home » Accounting Tutorials » Income Statement Tutorials » Gross Profit

Gross Profit

By Madhuri ThakurMadhuri Thakur | Reviewed By Dheeraj VaidyaDheeraj Vaidya, CFA, FRM

What is Gross Profit?

Gross Profit shows the earnings of the business entity from its core business activity i.e. the profit of the company that is arrived after deducting all the direct expenses like raw material cost, labor cost, etc. from the direct income generated from the sale of its goods and services.

Formula

It is calculated as below:

Gross Profit Formula = Revenue – Cost of goods sold

This formula only considers variable costs. Variable costs are the cost to the Company that varies with the output of the Company. It should be noted that the fixed costs are not considered when deducting the cost of goods sold from the revenue to calculate it.

Variable Costs include the following items:

  • Raw Materials
  • Labour
  • Packaging costs
  • Freight costs
  • Sales commissions

Gross Profit

Examples of Gross Profit

Example #1

A Company has a revenue of $ 50000, and its cost of goods sold was $ 30000. What is the gross income of the Company?

Solution:

gross profit example1.1

GP =$50,000 – $30,000

The GP will be –

gross profit example1.2

  • GP = $ 20000

Example #2

A Company in Auto manufacturing has the following items on its profit and loss statement. Calculate Gross Profit using the following data.

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gross profit example2.1

Selling and administrative expenses will not be added to the cost of goods since they are mostly fixed costs. Also, interest and financial expenses will not be added to the metric as they represent interest paid to the financers.

Gross Profit

example2.2

  •  $ 75000

GP Ratio will be –

example2.3

Therefore,  Gross Profit Ratio = 62.5%

Colgate Example

Let us calculate Colgate’s GP

Colgate’s GP = Net Sales – Cost of Sales.
For FY 2015, GP = $16034 – $6,635 = $9,399.

Colgate

Let us now calculate the Gross Profit Margin.

Ratio Analysis colgate

  • The cost of Operations includes the Depreciation related to manufacturing operations (Colgate 10K 2015, pg 63).
  • Shipping and handling costs may be reported in the Cost of Sales or Selling General and Admin Expenses. Colgate reported these as a part of Selling General and Admin Expenses.

Gross Margin - Colgate 10K

  • If such expenses are included in Cost of Sales, then the Gross Ratio of Colgate would have decreased by 770 bps from 58.6% to 50.9% and decreased by 770bps and 750 bps in 2014 and 2013 respectively.source: – Colgate 10K 2015, pg 46

Methods to Increase the Gross Profit

Two methods can increase it:

#1 – Increase the price of products

The increasing price of products may decrease the number of products sold and thus, decrease the revenue as the customers will prefer buying a competitor product at a lower price. The price increase should be done by taking into account the inflation, competition, demand, and supply of the product, quality of the product, and USP (unique selling point) of the product.

#2 – Decrease the cost of products

Variable costs can decrease by a decrease in the inputs of the goods, i.e., raw material or by the production of goods efficiently. By purchasing raw material in bulk from the supplier, the Company can get discounts. Raw material costs can be decreased by purchasing material from a supplier that provides products at a cheaper rate. However, it may hamper the quality of the product. The Company can maintain or reduce costs by producing the goods efficiently.

Conclusion

Gross profit is the amount of profit made by the Company after deducting the costs of goods sold or the costs associated with the services the Company has provided. It is available on an income statement before deducting selling, general and administrative expenses (SG&A) and non-operating revenues, non-operating expenses, other gains, and other losses.

Gross profit and its ratio are two key indicators that the investors look in the Companies income statement. These provide a view on the financial performance of the Company. I.e., how well it manages the demand and supply of the goods and manages the variable costs associated with the production and sales of the goods.

Recommended Articles

This article has been a guide to what is Gross Profit, its definition. Here we discuss how to interpret Gross Profit and with examples and strategies to increase the same. You can learn more about accounting from the following articles –

  • Profit and Loss Statement Template
  • Calculate Depreciation Expense
  • What is Gross Profit Margin?
  • Compare Profit and Income
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