17 Apr What is Gross Profit?
One of the few times where gross doesn’t have a negative connotation, this article explains a primary account that many investors and creditors will look at.
What is Gross Profit?
Gross profit is the profit you make after deducting the costs associated with selling your product or revenue.
The calculation for this account is simple : Revenue – Cost of Goods Sold = Gross Profit.
As you’re aware, just because you made $100,000 in revenue doesn’t mean you gained $100,000 of cash.
You have to spend money to make money, and gross profit measures the amount of money you made over the amount of money you spent to make it.
The key item to remember here is that gross profit is different from operating or net profit.
Gross profit only calculates revenue and cost of goods sold. It does not take operating expenses into account. Operating expenses include normal expenses such as Rent, Utilities, General, and Administrative, etc.
From a functionality standpoint, gross profit isn’t the most important account. It’s merely a sub account to show the difference between revenue and COGS.
However, it is an account that many investors and creditors will look at. It’s an initial figure of measurement for them.
They want to first make sure that your revenue is good revenue. Any company can produce $100,000 in revenue – but it’s worthless if you have little gross profit to show.
If your gross profit is acceptable, then your business will usually have the potential to succeed, even if it isn’t doing great now. If you can show that your service or product is profitable, other expenses can generally be streamlined to help the bottom line.
Examples of Gross Profit
Gross Profit is an account that shows the difference between revenue and COGS, it isn’t a tangible account that has any associated products or services.
With this, there aren’t any examples to show. It’s important to remember that some companies don’t have COGS and their gross profit will equal net revenue, but outside of that, gross profit is not a diverse account.
Gross profit is also referred to as gross margin, sales profit, or gross income.
Gross Profit’s Role in Accounting
Type of Account
Gross Profit is a profit account. The account itself does not have any transactions, it merely represents the difference between revenue and cost of goods sold.
Since it shows the difference between two income statement accounts, gross profit is also an income statement account.
Gross profit will always come immediately after Cost of Goods Sold.
If a company doesn’t have COGS, then gross profit will come after revenue.
Essentially, gross profit will always be the account shown before jumping into operating expenses.
The following example provides a visual of this:
For the example, let’s assume our company sells stickers. It costs $0.40 to make the stickers, and they sell them for $1.00.
In January, we sold 1,000 stickers.
Gross Profit on an income statement
The above example shows our gross profit. As mentioned above, we sold 1,000 stickers for $1 a sticker.
This creates a revenue of $1,000. However, we know that this $1,000 is not all cash gained for us. We had to spend money to produce the stickers for resale.
At $0.40 a sticker, 1,000 stickers equals $400.
The difference between the two is $600, our gross profit.
Gross profit will never have a journal entry.
Gross profit in itself is not an account. It represents the difference between actual accounts, revenue, and cost of goods sold.
Gross profit will never change without these accounts changing.
Other Areas of Impact
Gross profit is an important measure that shows how profitable your sales are.
Gross profit is represented as a numerical figure, but it’s important to look at it as a percentage of revenues.
This percentage will differ with every industry, but it’s important to compare your gross profit to the industry average. This will provide accurate detail on if your gross profit is acceptable or needs improvement.
This percentage is also referred to as Gross Profit Margin.
Gross Profit Recap
- Difference between Revenue and COGS
- Shows how profitable your sales are
- Located after COGS and before operating expenses
- Not an actual account, merely represents a total
- Should not be confused with Operating or Net Profit