Gross Profit

Equivalent to total sales, it is a company’s total revenue minus the cost of goods and services sold; the profit a company makes after deducting the costs associated with making and selling its products and/or the costs associated with providing its services.

 

Subtracting the cost of producing goods/services that have been sold from a company’s revenue (commonly referred to as profit from sales) results in a calculation of gross profit. This calculation is also referred to as gross income or sales profit. While this calculation is informative in regards to a company’s profits versus the variable costs associated with doing business, gross profit generally does not take fixed costs into account so it is somewhat limiting.

 

Practically speaking, this means that gross profit takes into consideration the costs of doing business that fluctuate as goods and services are produced but does not usually take into consideration fixed costs that will need to be paid regardless of whether the company is effectively producing goods/services or not. Materials, shipping, output-dependent labor and other fluctuating costs factor into the calculation of gross profit, while fixed costs including rent, salaried labor (and other non-output-dependent labor), insurance, etc. that must be paid regardless of production output are generally not factored into calculations of gross profit.

Why would a company need to understand its total revenue minus its unfixed costs instead of simply evaluating its total revenue minus its total (fixed and unfixed costs)? Gross profit helps in the assessment of how efficient a company is being in regards to managing its materials and labor.

 

EXAMPLE:

Kid: “If lemons, sugar, cups and hiring Joey to watch the stand for the weekend while I’m at Aunt Lucy’s house costs me $25/day, but I am making $50/day, I am making a gross profit of $25/day.”

Mom: “What about the money you owe your dad for the construction materials for the stand?”

Kid: “That is effectively rent and is a fixed cost, Mom. Fixed costs don’t factor into gross profit calculations. Geez!”