Gross Profit Meaning
The term "gross profit" is a financial accounting and tax term used by businesses to describe a company's revenue in connection with sales for products or services, before certain costs are considered. The amount calculated for the gross profit of a company or business entity is the amount of sales profit, before deducting costs for general overhead, payroll, interest payments and taxation. The amount calculated as gross profit differs from "operating profit," which is the earnings amount before merely interest and taxes are considered.
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Calculating Gross Profit
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To calculate the amount of gross profit for a business entity, starting with the total sales or gross revenue amount, deduct the total sales or manufacturing costs of the goods provided. For example, an item that is sold for $10, which costs $4 to manufacture (also known as the cost of goods or wholesale cost), would have a gross profit of $6.
You also may divide the gross profit amount by the gross sales revenue amount to arrive at the percentage gross margin, which is another known measure of profitability. As illustrated above, you would begin with the gross profit of $6 against the revenue of $10, to arrive at a 60 percent gross margin.
Methods of Accounting
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In accounting and taxation, there are three general methods for determining whether or not an income stream is appropriate to include in the gross income tally. First, there is the cash method, under which the taxpayer reports the gross income at the time of the actual receipt of cash or its equivalent. Secondly, the accrual method allows taxpayers to include items at the time they are earned to claim deductions when expenses are incurred. Finally, the hybrid accounting method combines aspects of both the cash and accrual methods.
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Gross Income Realization
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It is possible to realize gross income in any form, whether it comes from cash, property or services. For a taxpayer to be charged with income, there needs to be a realization occurrence. The realization process involves three separate components. The severance component includes gain that is physically separable from the producer of such gain. For example, if a home owner has a house that was acquired for $150,000 in 1995, by 2003, the fair market value would have increased to $400,000. The homeowner would not realize the $250,000 increase, since it is not technically physically separable from the house. In contrast, dominion and control means that the amount considered is actually available for immediate benefit, use or disposal by the taxpayer.
Items Excluded from Gross Income
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Some items are excluded from gross income, according to Internal Revenue Code. For example, certain gifts are usually not considered as income for recipients. When taxpayers receive gifts, they are considered to have an "undeniable accession to wealth" that is "clearly realized" and therefore has "complete dominion" over those items. The United States Revenue Code,Title 26, Part III, describes how gifts are specifically excluded from gross income. Other items excluded from gross income calculations can include certain kinds of compensation for worker's compensation or illness, damages, insurance payments, pensions, annuities or disability income from military related injuries incurred. As a general rule, however, all income, from whatever source, is considered gross income, unless specifically excluded by the IRC.
Accession
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An accession to wealth usually includes an inflow of cash, property, services, non-cash property or other items that are in excess of the initial capital that was invested in a business. For example, if a company owner purchases an item for $500 in October and then sells it in November for $700, he has gross income of $200 (which would be the $700 received minus the $500 basis).
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References
- Photo Credit dictionary definition - profit image by Chad McDermott from Fotolia.com
