What Is Gross Profit and How Do You Calculate It?

The formula and a simple example

Gross profit equals net revenue minus cost of goods sold (COGS). Divide it by revenue to get gross margin.

Gross profit = Revenue - COGS.

Example (illustrative): a bakery sells $50,000 of product in a month. Ingredients, packaging and the wages of the bakers who make the products total $30,000.

• Gross profit = $50,000 - $30,000 = $20,000
• Gross margin = $20,000 / $50,000 = 40%

Gross profit is a dollar amount. Gross margin is the same figure expressed as a percentage, which lets you compare periods and businesses of different sizes. It sits near the top of the income statement.

What counts as cost of goods sold

COGS includes costs directly tied to making or delivering what you sold: materials, direct labor and production supplies. Overhead is excluded.

For a product business, COGS is usually the cost of inventory sold, freight in, packaging and the labor that makes the item. For a service business, it is the direct labor and subcontractor cost of delivering the service, plus job-specific materials.

Generally not in COGS: rent for your office, owner salary, advertising, insurance, software subscriptions and loan interest. Those are operating expenses and appear below gross profit. Where a cost falls can be a judgment call, so be consistent and ask your accountant. Our guide to calculating cost of goods sold shows the inventory formula, and inventory accounting explains the tracking.

Gross profit versus net profit and operating profit

Gross profit ignores overhead. Operating profit subtracts overhead. Net profit subtracts everything, including interest and taxes.

Continue the bakery example:

• Gross profit: $20,000
• Operating expenses (rent, utilities, marketing, admin pay): $14,000
• Operating profit: $6,000
• Interest and taxes: $1,500
• Net profit: $4,500

A business can have a healthy gross margin and still lose money if overhead is too high. Reverse the problem too: a thin gross margin leaves little room to cover overhead at all. See calculating net profit and operating margin for the next levels.

Using gross margin to price correctly

Price must cover direct cost plus enough margin to pay overhead and leave a profit. Markup and margin are not the same number.

A common mistake is confusing markup with margin. If an item costs $60 and you add a 40% markup, you charge $84. The margin on that sale is $24 / $84, or about 28.6%, not 40%. To earn a 40% margin on a $60 cost, you need a price of $100.

Quick formula: price = cost / (1 - target margin). Check your price against your overhead. If your costs are $14,000 a month and your gross margin is 40%, you need roughly $35,000 in monthly revenue just to break even at the operating level. See the break-even point formula and small business pricing.

Ways to raise gross profit

Raise prices, lower direct costs or shift your sales mix toward higher-margin items. Even small changes compound.

1. Review prices. A 3% increase on an unchanged cost base drops almost entirely to profit.
2. Negotiate with suppliers. Volume commitments or earlier payment may reduce unit cost. See how to find suppliers.
3. Cut waste and returns. Spoilage, rework and shrinkage hit COGS directly.
4. Change the mix. Promote products with higher margins, and drop items that sell but lose money.
5. Raise productivity. Better scheduling lowers direct labor per job.

Track gross margin by product line or job type, not only in total. A blended 40% can hide a 15% product that drags the business down.

Typical margins vary by industry

There is no universal good margin. Compare yourself with your own history and with businesses of the same type.

Software and consulting firms often have high gross margins because their direct costs are low. Grocery stores, distributors and contractors generally run lower margins on much higher volume. Rather than quoting figures here, look up benchmarks from your trade association or ask your accountant for ranges in your field. For general profitability measures, see what is a good profit margin for a small business.

What matters more is trend. If your gross margin slipped from 42% to 36% over a year, find out why: supplier price increases, discounting, a changed mix or labor overrun.

Gross profit and your funding case

Funders and you both want to know if growth will add gross profit. Money spent to raise sales only helps if the margin on the extra sales is real.

Illustrative example: you can buy $20,000 more inventory and expect to sell it for $35,000. Gross profit is $15,000, a 43% margin. If financing costs $3,000 in total, the net gain before overhead is $12,000. That is the kind of payback math ROI Funder starts from. Read inventory funding payback math and how to calculate loan ROI.

ROI Funder places working capital, lines of credit and more for businesses with 500+ FICO, 6+ months in business and $20,000+ monthly revenue, with the true cost shown before you sign.