Gross Profit

Back to Basics: Gross Profit

When you’re analyzing your company’s financial health, it’s important to pay attention to your gross profit and gross profit margin.

Gross Profit

Your gross profit shows how well your company creates your product or provides your service.

To determine your gross profit, you need your sales numbers and cost of goods sold (COGS). Your COGS are the costs directly related to purchasing products for resale or manufacturing products to sell.

Variable Costs vs Fixed Costs

Variable costs change based on the amount of product you’re producing – they’re incurred as a direct result of producing your products or providing your services. They include:

  • materials used,
  • direct labor,
  • packaging,
  • shipping,
  • plant or warehouse utilities, and
  • machinery.

Fixed costs, on the other hand, don’t change based on how much you produce. Fixed costs are operating expenses and aren’t included in your COGS. They include:

  • office supplies,
  • salaries and wages of your office staff or salespeople,
  • payroll taxes,
  • employee benefits,
  • advertising expenses, and
  • rent.

Calculating Gross Profit

If your sales were $20,000, and your COGS were $15,000, your gross profit is $5,000.

Gross Profit Margin

Your gross profit margin expresses your profits as a percentage of your sales. It tracks your profitability trends.

If your gross profit is $5,000, and your sales were $20,000, your margin is 25%.

Improving Your Gross Profit Margin

Without an adequate gross profit margin, it can be difficult for your company to pay its operating expenses. To improve your margin, you can increase your prices or decrease your COGS.

Before you decide to increase your prices, pay attention to your competitors’ rates and the demand for your product. If you price your products too high, you’ll lose sales.

You can also decrease your COGS by manufacturing your products more efficiently. Work with your suppliers to get volume discounts for buying materials in bulk. If your suppliers won’t give you a discount, consider finding a cheaper supplier.

Markup

Your markup is related to your margin, but instead of being a percentage of sales, markup is a percentage of costs.

If you sell your product for $20 and spent $15 to produce one product, your markup is 33%.