If a company wants to determine its gross profit [1], it would take all of the revenue [2] 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 [3] 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 [4] 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 [5] or Generally Accepted Accounting Principles [5]. If you are looking to calculate this figure on your own, here is the exact formula. Total Revenue – Cost of Goods Sold [6] (COGS [6]) = 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 [7] 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 [8] processing costs, etc. The actual profit margin [9] 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.