Want to know how much return you’re getting against your investment? To find out, you need to work out your profit margins. If you are a business owner, keeping track of your profit margins regularly will provide you with in-depth information about the most profitable areas of your business. With this information, you can focus on those areas to scale up your business. Though calculating the profit margins seems simple but when it comes to gross profit, it becomes a bit complicated. So today we’ll have a look at how to calculate gross profit. Let’s dive in!
Why Do You Need to Calculate Profit?
Profit indicates the performance of the business. When there is a large flow of incomings and outgoings, it is difficult to work out how much money your business is actually generating. By measuring the profit over a certain period, you come to know the financial health of your business and can know how much money you’re using on expenses. Calculating profit is important to expand your business. Thus, the profit paves the way for new opportunities for your business growth.
What is Gross Profit?
The gross profit is your business’s total sales/turnover/revenue minus the cost of goods sold (COGS). The total sales include all the goods and services sold by the company. And people often misunderstood COGS with expenses. Let’s delve into the details of COGS and revenue.
Cost of Goods Sold (COGS)
It includes all the direct costs and expenses that are used for manufacturing or acquiring the goods or services that you sell. Indirect costs, like sales and marketing costs, staff salaries are excluded from it. Here are some of the examples of COGS:
- The cost of raw materials for manufacturing/producing goods
- Direct labour costs associated with the production
- Shipping costs
- Time spent on facilitating a client
- Cost of equipment used for manufacturing
- Utilities for the production facility
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What is Revenue?
The amount of income a business makes by selling its goods and services is called revenue. It shows how much money your business is generating from your total sales. It doesn’t include the operating expenses like taxes, depreciation, etc.
How to Calculate Gross Profit
Here is the simple formula to work out the gross profit:
Gross Profit = Revenue/Sales – Cost of Goods Sold (COGS)
Suppose you are running a small boutique, and you bought the stock from a wholesaler at £100,000. And you get annual returns of £250,000 from it. It means your gross profit would be £150,000 (£250,000 – £100,000).
Let’s take the example of a service-based business. An accounting firm is providing auditing services. A single audit costs them around £300 and they sell it for £700. It means they yield £400 gross profit.
Difference Between Gross Profit and Net Profit
Gross profit shows the remaining profit after subtracting the production cost from the revenue. It is a snapshot for the investors to determine how much profit a business earns from the production and sales of its goods and services.
Contrarily, net profit is the remaining money you get after deducting all allowable expenses from the gross profit. It includes things like rent, stationery, staff salaries, taxes and so on.
Importance of Gross Profit
Gross profit, along with other profit margins, indicates how efficiently a business is performing to generate income from its products and services. It shows whether a profit margin for a product or service is enough or it needs improvements to get maximum output. In simple words, it indicates whether a business is in profit or loss.
Quick Sum Up
Now that you know how to calculate gross profit, you can effectively use it to measure your business’ performance and to set targets for the future. Gross profit is one of the key matrices to know how much revenue you have got after deducting the cost of the production. A high gross profit means you’re making money against the cost of a product, whereas a low gross profit shows that your sale price is lower than the product cost. But bear in mind that while these figures are useful references, they do vary on many factors like the industry type and company size.
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Disclaimer: This blog provides basic information on calculating gross profit.