How to Calculate Gross Profit

How to Calculate Gross Profit

21 March, 2023

As a business owner, you must keep track of how your venture performs. Revenue is an excellent indicator of your business’ performance. More importantly, within your company’s revenue, you need to focus on gross profit margin to gauge your business’ success. Thus, you must learn how to calculate gross profit margin and understand how it can be helpful for your business.

What is Gross Profit Margin?

Gross margin refers to the percentage of your company’s revenue remaining after accounting for the cost of goods sold (COGS). Although the words ‘gross profit’ and ‘gross margin’ are used interchangeably and connote similar things, they are slightly different. While gross profit gives you an idea of how much profit a business earns, gross margin indicates how much profit is retained against ₹1 of its revenue. In simple terms, while gross profit highlights the performance of the business, gross margin shows the company’s financial health.

Do note that gross profit is different from net profit. Gross profit is the net sales after deducting COGS. Net profit refers to what is left over from the gross profit after deducting indirect expenditure.

Thus, it is essential to first calculate gross profit to arrive at the gross profit margin.

How to Calculate Profit Margin?

To arrive at gross margin, first, you need to calculate profit. However, to determine profit, you need to know COGS. The steps and formulas for calculating gross profit margin are as follows:

  • Step 1- Calculate the COGS:

    COGS= [(cost of inventory at the beginning of accounting period + purchases) – the cost of inventory at the end of the accounting period]

  • Step 2 - Use COGS to calculate gross profit:

    Gross Profit = (Net Sales – Cost of Goods Sold)

  • Step 3 - Use gross profit to calculate gross profit margin:

Gross Profit Margin = Gross Profit / Total Revenue

Since gross profit margin is always denoted in percentage terms, you can multiply the figure by 100.

How Can Calculating Gross Profit Margin Be Helpful For Businesses?

Calculating Gross Profit Margin can help your business in the following ways:

  1. Retention: Since gross profit margin measures the relationship between your company’s gross profit and total sales, it is a strong indicator of financial health. It gives investors and shareholders an idea of the company’s efficiency and ability to manage costs. It also shows the amount of money your company can retain and reinvest into operations.

  2. Financial footing: Gross profit margin can help gauge a company’s financial footing over time. It can help investors see how your company’s gross margin has fared across accounting periods. If there is a drop in gross profit margin, it can bring you to address pertinent issues that are damaging the margin.

  3. Comparison: You can use gross profit margin to compare companies having different market capitalisations. It can help you understand how the relationship between differing profits and revenue works. You can use this data to take the actions required to boost your profit margin.

Now that you know more about calculating gross profit margin, overseeing your company’s performance will become much easier.

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