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 formula is written as:
Sales Revenue used in Gross Profit Formula
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 Sold used in Gross Profit Formula
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.
For example, 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.
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
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 formula tells us that Revenue = Cost of goods sold + Gross profit. So if gross profit is 30% of revenue, then cost of goods sold must be the remaining 70% of revenue. This is demonstrated in the diagram below.
If variable costs are 70% of revenue it follows that:
Cost of goods sold = 70% x Revenue
Revenue = Cost of goods sold / 70% = 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
The check is that Gross profit % = Gross Profit / Revenue = 128,571 / 428,571 = 30%
The gross profit formula is very useful for calculating the gross profit of a business. The gross profit is an important concept as it represents the true income of a business.
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 in 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 BSc from Loughborough University.