Financial Analysis

Jul 10, 2019

# Gross Profit Definition

Gross profit is the profit a company makes after deducting the costs associated with making and selling its products, or the costs associated with providing its services. Gross profit will appear on a company& income statement and can be calculated by subtracting the cost of goods sold (COGS) from revenue (sales). These figures can be found on a company& income statement.

Gross profit may also go by sales profit or gross income.

The Formula for Gross Profit Is

?Gross?profit&?Cost?of?goods?sold\text{Gross profit} & \text{Revenue} - \text{Cost of goods sold}Gross?profit&?Cost?of?goods?sold?

1:37 Gross Profit What Does Gross Profit Tell You?

Gross profit assesses a company& efficiency at using its labor and supplies in producing goods or services. The metric only considers variable costs?– that is, costs that fluctuate with the level of output, such as:

materialsdirect labor, assuming it is hourly or otherwise dependent on output levelscommissions for sales staffcredit card fees on customer purchasesequipment, perhaps including usage-based depreciationutilities for the production siteshipping

As generally defined, gross profit does not include fixed costs, or costs that must be paid regardless of the level of output. Fixed costs include rent, advertising, insurance, salaries for employees not directly involved in the production?and office supplies.

However, it should be noted that a portion of the fixed cost is assigned to each unit of production under absorption costing, which is required for external reporting under the generally accepted accounting principles (GAAP). For example, if a factory produces 10,000 widgets in a given period, and the company pays $30,000 in rent for the building, a cost of$3 would be attributed to each widget under absorption costing.

Gross profit shouldn& be confused with?operating profit, also known as earnings before interest and tax (EBIT), which is a company& profit before interest and taxes are factored in. Operating profit is calculated by subtracting operating expenses from gross profit.

Key Takeaways Also called gross income, gross profit is calculated by subtracting the cost of goods sold from revenue.Gross profit only includes variable costs and does not account for fixed costs.Gross profit assesses a company& efficiency at using its labor and supplies in producing goods or services.

The Difference Between Gross Profit and Gross Profit Margin

Gross profit can be used to calculate the gross profit margin. Expressed as a percentage of revenue, this metric is useful for comparing a company& production efficiency over time. Simply comparing gross profits from year to year or quarter to quarter can be misleading, since gross profits can rise while gross margins fall, a worrying trend that could land a company in hot water.

The terminology here can cause some confusion: & margin& can be used to mean either gross profit and gross profit margin. Gross profit is expressed as a currency value, gross profit margin as a percentage.?The formula for gross profit margin is as follows:

?Gross?margin&?Cost?of?goods?sold)Revenue\text{Gross margin} & \frac{\left(\text{Revenue} - \text{Cost of goods sold}\right)}{\text{Revenue}}Gross?margin&?Cost?of?goods?sold)??

Gross profit margins vary greatly by industry. Food and beverage stores and construction firms have razor-thin gross profit margins, for example, while the healthcare and banking industries enjoy much larger ones.

Example of How to Use Gross Profit

Here is an example of how to calculate gross profit and the gross profit margin, using Ford Motor Co.& 2016 annual income statement:

Revenues(in USD millions)Automotive141,546Financial services10,253Other1 Total revenues151,800Costs and expensesAutomotive cost of sales126,584Selling, administrative, and other expenses12,196Financial Services interest, operating, and other expenses8,904 Total costs and expenses147,684

To calculate the gross profit, we first add up?the cost of goods sold, which sums up to $126,584. We do not include selling, administrative and other expenses since these are mostly fixed costs. We then subtract the cost of goods sold from revenues to obtain a gross profit of$151,800 - $126,584 &$25,216 million.

To obtain the gross profit margin, we divide the gross profit by total revenues for a margin of $25,216 /$151,800 & 16.61%. This compares favorably to an automotive industry average of around 14%, suggesting that Ford operates more efficiently than its peers.

Limitations of Using Gross Profit

Standardized income statements prepared by financial data services may give slightly different gross profits. These statements conveniently display gross profits as a separate line item, but they are only available for public companies.

Investors reviewing private companies& income should familiarize themselves with the cost and expense items on a non-standardized balance sheet that do and don& factor into gross profit calculations.

For more on gross profit, read more about profit metrics and gross, operating, and net profits.

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