Gross Profit and Gross Profit Margin – Definition, Calculations
Gross profit and gross profit margin are important financial metrics that help evaluate a company's operating performance and financial health.
What is gross profit?
Gross profit is calculated by subtracting the cost of goods sold (COGS) from total revenue. It reflects the amount of money left after deducting the direct costs associated with manufacturing or providing a service.
For example, if a company has revenue of $500,000 and COGS is $300,000, then the gross profit would be $200,000.
What is gross profit margin?
Gross profit margin is calculated by dividing gross profit by total revenue and multiplying by 100 to get a percentage:
Gross profit margin (%) = (Gross profit / Revenue) x 100
This ratio shows the percentage of revenue retained after deducting direct production costs.
Why is gross profit important?
- Measure production efficiency: Gross profit shows the ability to control production costs and the efficiency in creating a product or service.
- Compare industries: Helps a business compare its performance to competitors in the same industry.
- Attract investors: A stable gross profit margin can attract investor interest.
What is a good gross profit margin?
The ideal gross profit margin depends on the industry and business model. For example, according to CFO Hub, the average gross profit margin is around 30–35%, but it can vary significantly between industries.
Limitations of Gross Profit
Although an important metric, gross profit does not include operating expenses such as marketing, rent, and employee salaries, so it does not fully reflect a business's net profit.
Conclusion
Understanding and tracking gross profit and gross profit margin helps businesses evaluate operating performance, compare it to industry standards, and make appropriate strategic decisions.