What is gross profit?
The gross profit of a business refers to the company’s total sales income after the costs of producing the goods or services sold have been deducted. Reported as a numerical figure, it gauges a company's efficiency at utilising its labour and supplies in producing services or goods. Unlike net profit, the gross figure includes other costs, such as overheads and tax.
Gross profit is generally used to calculate the gross profit margin. This figure, expressed as a percentage of the sales revenue, allows the comparison of a company's production efficiency over time. A gross profit margin is commonly used for this reason because comparing gross profits on a quarterly or annual basis can be deceptive, as gross profits can stay the same or rise while gross profit margins decrease.
Note that the gross profit meaning should not be confused with that of operating profit, commonly known as EBIT, which is a company's profit obtained after deducting the cost of production and operating expenses from the net sales without taking interest and taxes into consideration.
Where have you heard about gross profit?
Gross profit is a familiar term in business, and of great importance to every company and investor as an indicator of performance and potential.
Therefore, you may have heard about the term from a variety of online and offline sources, including financial newspapers, TV news reports and the internet. Moreover, your investment manager or financial advisor may have recommended keeping your eye on a company's gross profit when making investment decisions.
What you need to know about gross profit.
When calculating a company’s gross profit, the following formula is applied:
How does it work in real life? For example, assume that a company has total sales of $10,000. Its cost of production of goods sold is $3,000. Therefore, the company's gross profit is $7,000.
The costs of goods sold include those that are incurred as a direct result of manufacturing the product and they can change based on the amount of production output. These include:
- Raw materials
- Depreciation expense on production equipment
- Direct labour
- Plant supervisor salaries
- Utilities for a plant or a warehouse
A company's gross profit is usually reported quarterly, and certainly annually and is typically stated partway down the income statement. It is a way to see exactly how much money the business is making, when the direct costs of production are taken into account.
But it has to be looked at alongside the gross margin, to understand whether the profit figure represents efficient management of costs. The margin may be declining, even if the gross profit figure is higher, meaning costs as a proportion of income have gone up.
Together these two bits of data can give a good indicator of the company's performance in the context of its industry, the market and its own forecasts and expectations. It is one of the figures reported by companies that will impact on the share price.