What is gross profit, and how to calculate it

Gross profit calculations can provide a look at your business’s financial health. By understanding your gross profit, you can get a data-backed view of how efficiently your company is using resources during business operations.

Continue reading to learn more about gross profit and how to calculate it.

What you’ll learn:

• Gross profit measures profit by focusing on product-specific costs.
• To calculate gross profit, subtract the total cost of goods sold (COGS) from the total revenue.
• Calculating gross profit can help business owners assess how efficiently their business is utilizing its labor and material costs and identify which products and services are most profitable.

Gross profit—also known as sales profit or gross income—measures the money your company’s goods or services earned after subtracting the total costs to produce and sell them. In other words, it’s calculated by subtracting the cost of goods sold (COGS) from the revenue made from sales. It’s an easy formula that should help you measure the value your goods and services bring to your business. Investors and business owners evaluate their company’s gross profit in order to understand the impact of price changes on profitability. 

The formula to calculate gross profit is the total revenue minus the COGS.

Total Revenue − Total COGS = Gross Profit

COGS includes only variable costs—such as hourly wages or materials—associated with the production of a good or service. Variable costs are those that change as the production output changes. They may include:

• Materials and parts
• Labor costs for staff directly involved in production
• Packaging and shipping costs
• Equipment operation costs (which may include utilities)
• Processing fees for consumer purchases
• Depreciation of equipment
• Sales commissions

COGS doesn’t usually include fixed costs, such as marketing budgets, labor unrelated to manufacturing (like executive pay), insurance, software and other subscriptions, equipment leases, and property taxes.

Total revenue refers to the net sales or the total amount of money earned from the sale of your business’s products or services. Usually, this income amount isn’t adjusted to account for expenses like business overhead, taxes or interest. It only reflects the money earned from sales. It may include deductions from discounts and returns.

As an example of calculating gross profit, consider a doughnut shop that had $209,060 in total revenue and $129,835 in COGS. In this example, the total gross profit for the first quarter of 2022 is $79,225.

$209,060 − $129,835 = $79,225

Imagine that you own this doughnut shop. Your variable expenses include raw materials to make the dough, icing and coffee drinks; paper goods, cups and lids; toppings and add-ons; wages for your team; and processing fees for customer purchases. If you want to calculate the gross profit for your entire business (not just the coffee drinks) for the first quarter of the year, you would first need to total your revenue and variable costs.

Your spreadsheet to calculate the gross profit would look something like this:

Calculating gross profit is important because it gives you a clear understanding of your company’s financial health. Beyond demonstrating how much profit your offerings generate for your business, gross profit calculations can shed light on the efficient use of labor and company resources. A high gross profit typically indicates that you have optimized your process and material choices to deliver profitable goods or services quickly and affordably. 

At the micro level, gross profit calculations can help you decide whether a particular product or offering is generating revenue. If a specific product has high material and labor costs and a small gross profit, you may need to optimize your production process, reevaluate supplier contracts or consider removing the item from your product line. Additionally, estimations can inform more significant business decisions, like steps to take during an economic downturn or where to reinvest profits after a successful quarter.

Although similar in name, gross profit and gross profit margin aren’t the same and shouldn’t be used interchangeably. Gross profit represents a fixed currency amount, while gross profit margin is identified as a percentage or ratio.

Since a company’s gross profit can vary, depending on factors like company size and industry, most businesses calculate their gross profit margin to get a better sense of their business performance. Gross profit margin indicates the percentage of your business revenue that is profit, and it’s helpful when you’re comparing your business to other businesses in the industry. 

To calculate your gross profit margin, divide your gross profit by your total revenue and multiply it by 100.

Gross Profit ∕ Total Revenue ✕ 100 = Gross Profit Margin

For the doughnut shop example above, the gross profit margin formula would look like this:

$79,225 ∕ $209,060 ✕ 100 = 37.89

The doughnut shop’s gross profit margin would be 38%. In some industries, anything above 20% is good, but in high-end industries like fine jewelry, a good gross profit margin may be above 50%. Larger companies also tend to have higher profit margin expectations than small businesses do.

Net profit, or net income, is another term that sounds similar to but differs from gross profit. Gross profit measures how efficiently a company uses labor and supply costs to produce its goods and services—it only considers the COGS. Net profit, on the other hand, measures profitability after all expenses—not just product-specific costs. 

Your gross profit should help inform important decisions in your business and may be key to its success. When you understand which goods are most profitable, which services are straining your earnings and how your business is performing, you’ll be more empowered to make strategic decisions to grow your business, weather hard times or develop a plan to improve performance.

Looking for more ways to help your business? Learn more about Capital One business credit cards and how they can support your business’s growth and credit health.