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How to calculate gross profit

Profit is an important word, but if you want to know more about your business’s financial health, you’ll need to dig a little deeper. Where there is profit, you’ll have gross profit and net profit. However, you’ll need to know the correct formulas to understand these terms in more depth. Let’s take a closer look at how to calculate gross profit.

What is gross profit?

Gross profit is the total amount of money your business has made after you take away the costs of production. Gross profit is able to show the profitability of your production process, or if you need to consider changing it in order to maximise revenue. This can include sourcing cheaper materials or investing in better equipment to improve efficiency.  

What’s the difference between net profit and gross profit?

Net profit tells you precisely what your bottom line is, while gross profit looks at how much you make from the cost and sale of your goods before you consider your usual fixed costs. Gross profit mostly considers variable costs, including:

  • Materials

  • Labour

  • Shipping

  • Equipment

Net profit margin will take into account things such as:

  • Tax

  • Interest

  • Operating expenses

  • Rent

  • Insurance

  • Amortization

This means gross profit gives a clearer picture of how optimised your production processes are, while net profit shows your overall ability to make money. A low gross profit margin suggests that your production methods or materials are not cost-effective.

Gross profit formula

The gross profit formula is:

Revenue – Cost of Goods Sold = Gross Profit

This can be adapted to find the gross profit margin. The gross profit margin is a percentage. For year-to-year tracking of your gross profit, the gross profit margin formula should be used, not the number of your gross profit itself. Your gross profit may change year on year, but your gross profit margin should remain similar – you definitely don’t want it to drop.

The gross profit margin formula is:

(Revenue – Cost of Goods Sold) / Revenue = Gross Profit Margin

What is a good gross profit margin?

This depends on your industry. if you want to understand how good your gross profit margin actually is, you should look at your competitors. In very basic terms, a margin of around 20% is considered “good”, but in the automobile industry, for example, a slightly lower gross profit margin can still be considered healthy.

How can businesses improve their gross profit?

If you sell a product, rather than a service, you can aim to improve your gross profit by working with your suppliers. It may seem counterproductive, but ordering more from your suppliers can qualify you for bulk discounts which are better value overall. You could also consider raising the price of your product or maximising sales, i.e., by concentrating on better marketing efforts.

If you sell a service, then improving efficiency will be key to your gross profit. Consider automation and software to help make every working hour as profitable as possible. If you work with subcontractors, negotiate with them to see if you can get a lower rate if you guarantee blocks of work, rather than one-off tasks.

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