What is gross profit and how to calculate it

You probably know how much money your business has coming in, but do you know how much you’re spending to produce and sell your product? Knowing how to calculate gross profit can give you a better sense of the financial health of your business and how efficiently your company is using resources during business operations. 

Continue reading to learn more about gross profit and how to calculate it.

What you’ll learn:

• Gross profit measures profit by focusing on product-specific costs.

• To calculate gross profit, subtract the total cost of goods sold (COGS) from the total revenue.

• Calculating gross profit can help business owners assess how efficiently their business is using its labor and material costs and identify which products and services are most profitable.

• Along with gross profit, metrics like gross profit margin, net profit, EBITDA and operating profit provide further insight into your business’s profitability and help you evaluate different aspects of your business’s financial health.

Gross profit—also known as sales profit or gross income—measures the money your company’s goods or services earn after subtracting the total costs to produce and sell them. It’s calculated by subtracting the cost of goods sold (COGS) from sales revenue. This simple formula helps measure the value your products or services bring to the business. Investors and business owners evaluate their company’s gross profit to understand the impact of price changes on profitability. 

Calculating gross profit helps you determine your company’s financial health. It shows how much profit your offerings generate before accounting for operating expenses, and it highlights how efficiently you’re managing production costs. A high gross profit can suggest that your pricing, production processes and material choices are contributing to strong profitability.

Gross profit can reveal whether a product is worth selling. A low gross profit margin may signal a need to improve production, renegotiate supplier contracts or discontinue the item. Insights into gross profit can also inform larger decisions about things like managing cash flow during downturns or reinvesting after a strong quarter.

The formula to calculate gross profit is the total revenue minus the COGS.

Total Revenue − Total COGS = Gross Profit

COGS includes the direct costs—often variable costs, like hourly wages or materials—associated with the production of a good or service. Variable costs are those that change as the production output changes. COGS may include:

• Materials and parts

• Labor costs for staff directly involved in production

• Packaging and shipping costs

• Equipment operation costs (which may include utilities)

• Depreciation of equipment

COGS doesn’t usually include fixed costs, such as marketing budgets, labor unrelated to manufacturing (like executive pay), insurance, software and other subscriptions, equipment leases and property taxes.

Total revenue refers to the total amount of money earned from the sale of your business’s products or services. This figure usually isn’t adjusted to account for business expenses—like overhead, taxes or interest—it only reflects the money earned from sales. Net sales represent total revenue after deducting discounts, returns and allowances.

As an example of calculating gross profit, consider a donut shop that had $209,060 in total revenue and $122,155 in COGS. In this example, the total gross profit for the first quarter of 2022 is $86,905.

$209,060 − $122,155 = $86,905

Imagine that you own this donut shop. Your variable expenses include raw materials for making the dough, along with icing, coffee drinks, paper goods, cups, lids, toppings and add-ons, and wages for your team. If you want to calculate the gross profit for your entire business (not just the coffee drinks) for the first quarter of the year, you would first need to total your revenue and then subtract your variable costs (COGS).

Your spreadsheet to calculate the gross profit might look something like this:

Imaginary Donuts, Inc.: Gross profit calculation (Q1 2022)

Gross profit is just one part of the bigger picture for understanding your business’s financial health. To really see how your company is performing, it helps to compare gross profit with other key metrics. Each tells a different story—whether it’s about your pricing strategy, cost structure or how efficiently your business operates.

Although similar in name, gross profit and gross profit margin aren’t the same and shouldn’t be used interchangeably. Gross profit represents a fixed dollar amount, while gross profit margin is identified as a percentage or ratio.

Since a company’s gross profit can vary depending on factors like company size and industry, most businesses calculate their gross profit margin to get a better sense of their business performance. Gross profit margin indicates the percentage of your business revenue that is profit, and it’s helpful when you’re comparing your business to other businesses in the industry. 

To calculate your gross profit margin, divide your gross profit by your total revenue and multiply it by 100.

Gross Profit ∕ Total revenue ✕ 100 = Gross profit margin

For the donut shop example above, the gross profit margin formula would look like this:

$86,905 ∕ $209,060 ✕ 100 = 41.57

The donut shop’s gross profit margin would be 41.57%. In some industries, a gross profit margin of 20% or more is considered good, but in high-end industries like fine jewelry, a good gross profit margin may be above 50%. Larger companies also tend to have higher profit margin expectations than small businesses do.

Net profit, or net income, is another term that sounds similar to but differs from gross profit. Gross profit measures how efficiently a company uses labor and supply costs to produce its goods and services—it only considers the COGS. Net profit, on the other hand, measures profitability after all expenses—not just product-specific costs.

Gross profit and EBITDA are both profitability metrics, but they measure different parts of a business’s financial performance. EBITDA—which stands for earnings before interest, taxes, depreciation and amortization—takes a broader view by factoring in operating expenses while excluding financing and accounting decisions. While gross profit evaluates product-level margins, EBITDA is often used to assess overall operational performance and cash flow potential. 

Investors and lenders frequently consider EBITDA when comparing companies across industries, as it removes factors such as taxes and financing decisions. This makes it easier to compare companies on an apples-to-apples basis.

Gross profit and operating profit both show how much money a company is making, but they tell different parts of the story. Gross profit is a quick check on whether your core offering is profitable, but it doesn’t include costs like rent, salaries or marketing. 

Operating profit digs deeper by subtracting those everyday business expenses too. This makes it a more accurate indicator of how well the company manages its overall operations. If you want to know whether your product is working, look at gross profit. If you want to know whether the business as a whole is running efficiently, look at operating profit.

A related metric, operating margin, expresses operating profit as a percentage of revenue—making it helpful for comparing profitability across businesses of different sizes. Both gross margin and operating margin help you understand your business’s profits better, but they differ in how detailed their calculations are and how they’re used and analyzed.

Your gross profit should help inform important business decisions, and it can be key to your company’s success. When you understand which goods are most profitable, which services are straining your earnings and how your business is performing overall, you’ll be more empowered to make strategic decisions—whether they’re about growing your business, weathering hard times or developing a plan to improve performance.

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