What is gross profit on the income statement?

What is gross profit?

The gross profit of a company is simply the total revenue from sales minus the costs of achieving those sales, or in other words, sales minus the cost of goods sold. Gross profit tells you how much money the company will make if it doesn’t pay any other expenses such as salaries, taxes, copying paper, utilities, or rent. Gross profit will not include (as opposed to net profit) items such as interest paid on loans or debts, taxes, depreciation, or amortization. It usually will not include one-time fees or credits as well.

Where can I find gross profit on the income statement?

When you look at the income statement, instead of searching for a needle in a haystack, Generally Accepted Accounting Principles (GAAP) require that gross profit be detailed and clearly presented as a separate line item so that you cannot miss it.

How can I calculate gross profit?

The formula for calculating gross profit is simple. You only need to subtract the cost of goods sold from the revenue:

Gross Profit = Total Revenue – Cost of Goods Sold (COGS)

Imagine you own a small business selling luxury shaving kits. After researching different suppliers, you finally found a reliable source and imported a British luxury shaving kit for $160. You paid $20 for various merchant fees and bank processing costs and other expenses directly related to the cost of goods. You paid $20 in inbound shipping costs to receive the shaving kit in your store. After creating a nice display for the new product and opening the doors for business the next day, a customer comes in and buys the shaving kit for $315. What is your gross profit?

To answer that question, all you need to do is create a quick mental income statement. You know you collected $315 from the sale. You know the cost of goods sold is $200 (cost of goods $160 + $20 in merchant and bank processing costs + $20 in inbound shipping costs). Now, all you have to do is take $315 and subtract $200 to arrive at $115, which is your gross profit.

Now imagine you’re running a sale with a 20% discount lowering the sale price of the luxury shaving kit from $315 to $252. Your costs remain the same at $200. This means your gross profit is $52. (Calculation: $252 in sales revenue – $200 in cost of goods sold = $52 gross profit). The 20 percent discount you offered cut 54.8% off your gross profit. So, as a business owner, you’ll want to think carefully before offering significant discounts.

What is the importance of gross profit?

Gross profit is important because it is used to calculate something called gross margin, which we will discuss separately. In fact, you cannot look at gross profit in isolation and know whether it is “good” or “bad.”

Is gross profit always calculated the same way?

Management accounting rules allow for a lot of leeway. Officials have some flexibility in determining whether a certain expense should be part of the cost of goods sold or part of another section called selling and general administrative expenses. This means you can look at two companies with very different gross profit levels on the same amount of sales, although it’s just a result of one management team deciding that a certain cost is part of the cost of goods sold, while another management team decides that the same cost is part of selling and general administrative expenses. There is not necessarily anything illegal happening when this occurs – reasonable people can differ about where some items should go on the income statement – but it creates problems because you can look at two almost identical companies and one reports a gross profit that is much higher than the other. It can be difficult to compare companies fairly for this reason.

More

About Gross Profit and Gross Profit Margin

A company with low gross profit margins can potentially make more money than a company with high gross profit margins. It’s definitely worth studying because this is one of those fundamental concepts that you definitely need to understand before opening the doors to your own business. Targeting a gross profit strategy and sticking to it can be a powerful way to expand your operations and convey a consistent pricing philosophy to customers.

Source: https://www.thebalancemoney.com/gross-profit-on-the-income-statement-357578

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