What is Gross Profit?
The gross profit formula is used to calculate gross profit. Gross profit, sometimes referred to as gross margin, is the difference between the revenue and the cost of goods sold for a business.
The gross profit equation is as follows.
Gross Profit (GP) = Revenue from Sales (R) - Cost of goods sold (COGS)
Sales Revenue
In accounting sales revenue refers to the monetary amount from the sale of goods and services in which the business normally trades and which were bought for the purpose of resale. Sales returns and allowances, and sales discounts are deducted to arrive at the sales revenue figure to use in the gross profit calculation.
Cost of Goods
Cost of goods sold is the costs associated with producing the goods which have been sold during an accounting period.
Rearranging the Gross Profit Formula
The gross profit formula can be rearranged in numerous ways to provide useful information depending on what information is already known.
To illustrate, if you only know the cost of goods sold and the gross profit percentage, you can calculate the revenue and the gross profit using the gross profit formula.
Accordingly the table below shows a few ways of rearranging the formula.
| Gross Profit Formula Use | Formula |
|---|---|
| Calculate gross profit | GP = R – COGS |
| Calculate revenue | R = COGS + GP |
| Calculate cost of goods sold | COGS = R – GP |
| Calculate gross profit % | GP% = GP / R = (R – COGS) / R |
| Calculate revenue | R = COGS / (1- GP%) |
| Calculate cost of goods sold | COGS = Revenue x (1- GP%) |
Example of how to use the Gross Profit Formula
To illustrate suppose a business knows that its cost of goods sold is 300,000 and its gross profit percentage is 30% and wants to find its gross profit.
The gross profit equation tells us that Revenue = Cost of goods sold + Gross profit. Consequently if gross profit is 30% of revenue, then cost of goods sold must be the remaining 70% of revenue. The diagram below illustrates the situation.
If variable costs are 70% of revenue it follows that:
Cost of goods sold = 70% x Revenue Revenue = Cost of goods sold / 70% Revenue = 300,000 / 70% = 428,571
Finally using the formula again
Gross Profit = Revenue - Cost of goods sold Gross Profit = 428,571 - 300,000 = 128,571
To show this is correct we can use these values to check the gross profit percentage is 30%.
Gross profit % = Gross Profit / Revenue Gross profit % = 128,571 / 428,571 = 30%
This formula gives a business an indication of how much money it has made after accounting for the cost of producing and selling its products or services. Gross profit is the true income of the business. The higher the Gross Profit, the better the business is performing in terms of generating profit from its operations.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.