If a company wants to determine its gross profit, it would take all of the revenue that is generated through the sale of products and/or services and would then subtract the cost of generating that revenue. In more simplistic terms, gross profit is calculated by taking the total of all the sales and then subtracting the cost of the goods or services sold. This number tells you how much a company would make if it did not need to pay other expenses such as salary, income taxes, office supplies, rent, electricity and any other costs that are associated with running a business.
If you are looking at a company’s income statement, you will see that the gross profit number is broken down into clearly labeled categories. This is due to the rules in accordance with the GAAP or Generally Accepted Accounting Principles. If you are looking to calculate this figure on your own, here is the exact formula. Total Revenue – Cost of Goods Sold (COGS) = Gross Profit.
It is important to calculate this figure of a company’s gross profit because out of the gross profit number comes the gross margin figure. For example, let’s say a company sells a product that cost $300 retail. The original cost of item is actually $200 including merchant fees, service charges, bank processing costs, etc. The actual profit margin on the item would be $100 for each product sold. The higher the gross profit, the more money there is for the company and its shareholders.