Word of the Week 'Gross Profit'


What is 'Gross Profit'

Gross profit is the profit a company makes after deducting the costs associated with making and selling its products, or the costs associated with providing its services. Gross profit will appear on a company's income statement, and can be calculated with this formula:

Gross profit = Revenue - Cost of Goods Sold

Gross profit is also called sales profit and gross income.

BREAKING DOWN 'Gross Profit'

Gross profit assesses a company's efficiency at using its labor and supplies. The metric only considers variable costs, that is, costs that fluctuate with the level of output, such as:

  • materials;

  • direct labor, assuming it is hourly or otherwise dependent on output levels;

  • commissions for sales staff;

  • credit card fees on customer purchases;

  • equipment, perhaps including usage-based depreciation;

  • utilities for the production site;

  • shipping; etc.

As generally defined, gross profit does not include fixed costs, or costs that must be paid regardless of the level of output. Fixed costs include rent, advertising, insurance, salaries for employees not directly involved in production, and office supplies. However, it should be noted that a portion of the fixed cost is assigned to each unit of production under absorption costing, which is required for external reporting under the Generally Accepted Accounting Principles (GAAP)​. For example, if a factory produces 10,000 widgets in a given period, and the company pays $30,000 in rent for the building, a cost of $3 would be attributed to each widget under absorption costing.