Gross profit

Gross profit is revenue minus the cost of goods sold. It is what remains from sales after paying for the products or services themselves, and it has to cover everything else: salaries outside production, rent, marketing, interest and taxes.

How to calculate it

1. Start with net revenue: sales minus returns, allowances and discounts.
2. Work out the cost of goods sold. For a business with inventory, that is opening inventory plus purchases minus closing inventory, plus direct costs such as freight in and production labour.
3. Subtract the cost of goods sold from net revenue.

Dividing gross profit by revenue gives the gross margin, a percentage that can be compared from one period, product or company to the next.

Gross profit, operating profit and net profit

Gross profit is the first subtotal on the income statement. Subtracting operating expenses, including SG&A, gives operating profit. Subtracting interest and income taxes then gives net profit. A business can have a healthy gross profit and still lose money if its overhead is too high.

On a tax return

Small businesses work out gross profit on their returns too. In the US, Schedule C subtracts the cost of goods sold from net receipts. In Canada, form T2125 has a cost of goods sold section and a gross profit line for sole proprietors and partners.

Why coding matters

Gross profit is only as good as the split between cost of goods sold and operating expenses. A supplier receipt for raw materials coded as office supplies moves cost out of cost of goods sold and makes the margin look better than it is. Coding each vendor the same way every time keeps the margin honest.