The gross profit of any a business is an amount of profit made by a company by deducting the cost of goods sold. Gross profit can be found on the income statement prior to deducing selling, non-operating expenses, general & administrative expenses and non –operating revenues, total gains and losses of a company.
How To Calculate The Gross Profit
The GP can be calculated using a formula that is:
Gross Profit = Sales Revenue – Cost of Goods Sold
To understand the GP, you must know the difference between the variable and fixed price.
The formula mentioned above considers variable costs that change based on the amount of the products that are being produced and that are incurred as a direct result of producing the product. It includes material used, direct labor, freight, packaging, etc.
On the other hand, fixed costs are more static in nature as this includes office expenses, salaries & wages, insurance, rent, etc.
Variable expenses are the cost of goods sold
Fixed expenses are operating costs
How Gross Profit Works
- GP is important as it reflects the core profitability of any organization before overhead costs and it illustrates the financial progress of your products and services.
- Businesses with higher GP margins have a competitive edge over the competitors, as they are able to charge a higher price for their goods or services. Moreover, they can pay less for direct costs.
- By calculating the profit margin, you will be able to compare other companies as a whole to determine profitability.
What Is The Sales Revenue?
Sales revenue or net sales is the amount obtained selling goods and services to customers
What Is Gross Margin?
GP serves as the financial metric utilized to determine the gross profitability of business operations. It reflects how well sales cover direct costs related to the production of goods. Its formula is:
Gross Margin = Gross Profit/ Total Revenue x 100
Gross Margin is explained in the percentage. For example, the company got a revenue of $100 million and cost of goods sold is $400 million, therefore, the gross profit is $100 million. Now
Divide $100 million into $500 million and the answer will be 20%.
How To Improve The Gross Margin?
There are two methods to improve the gross margin
- You Can Increase The Price Of Your Goods: An increase in the costs can result in dropping the sales. When the sales drop too far, you may generate enough gross profit dollars to cover operating costs. On the other hand, when you are producing price increases it requires careful reading of inflationary rates, basic supply, competitive factors and demand predictions for the product.
- You Can Decrease The Costs To Produce The Goods: This is the way to increase the gross profit margin to lower the variable cost for producing the products. It can be accomplished by decreasing the cost of material and making the product more efficiently. The more material you buy the more likely you will get the discounts.
Have any question or want to learn more? If yes, reach us at Ismail Alptekin Business Developer. Our team of professionals can help you explain everything related to your business revenue and how you can improve and grow it.