About Gross Profits

A gross profit is the profit left over after the cost of a product is subtracted. In equation form: gross profit equals the sales revenue minus the cost of goods sold.

Features

The definition of sales revenue is the money or credit received in exchange for a business' product. The term cost of goods sold refers to the price of products sold to customers during an accounting period. The cost of goods sold equals beginning inventory plus purchases minus ending inventory. The use of the term cost of goods sold is not typically applicable to service and financial companies because they do not make a product.

Function

The term gross profit is used to indicate a company's profit before operating costs salary expense, administrative expense, rent and utilities are subtracted. Taxes and depreciation are also not included in the cost of goods sold.

Benefits

A benefit to determining a company's gross profit is that it can be used to determine that company's gross profit margin. Gross profit margin equals gross profit divided by sales revenue. Looking at gross profit margin from year to year within a company and in comparison to other companies in the same industry is a way for a company to manage their prices, cost controls and purchasing policies. The higher the gross profit margin the better a company's management is, the higher the price for which a company can sell its product and the greater competitive advantage it has within its industry.

Size

Gross profit margins vary from industry to industry. They are high in software and pharmaceuticals while in commodity industries such as consumer goods the are lower.

Significance

The best illustration of gross profit is with an example (using fabricated numbers). In the oil industry, for instance, if 100 barrels of oil are sold for $100 each and the cost of producing that oil is $40 per barrel the gross profit to for the oil company is $60 per barrel, or $6,000. However, that is not the amount of money the company truly earns because it has operating costs such as the cost of exploration, administrative costs and utilities expense, which might cost $25 for each barrel of oil sold, plus the cost of taxes and depreciation, which could be $25 per barrel. Therefore, the net profit for the oil company is only $10 per barrel of oil sold, or $1,000, while the gross profit is $60 per barrel.