Understanding Gross Profit in the Income Statement

Overview:

Gross profit is the profit after eliminating products or services cost of goods sold from the total net sales. These profits are recorded in the entity’s income statement and are not recorded in the balance sheet.

Gross profit is not the net earning for the company, but the gross earning that entity receives after deducting the direct cost ( cost of goods sold) like raw material, direct labor, and direct overhead.

For example, if the phone cost is 500 USD and you sold the phone for 600 USD. Your gross profit from the phone is 100 USD.

This 100 USD is not considered the cost of labor or management fee that occurs for purchasing the phone, selling the phone, and any other cost like office rental fee.

How to calculate?

The income statement shows gross profit in the line below the cost of goods sold. In most cases, it stays in the third line in the income statement. If you are preparing your income statement, you can calculate your gross profit by

Formula:

Gross Profit = Revenues – Cost of goods sold.

  • Revenue here is sometimes called sales revenue, net sales, or revenue. It is the total sales an entity generates during a specific period.
  • The cost of goods sold here is an entity’s cost of the products or services they generate. Remember, the cost that reports here is only the cost for goods sold. The cost that incurs and is not related to the products above should not report here.

Analyzing Gross Profit

Gross profit is a very important figure for users, shareholders, investors, and the entity’s management. This profit also lets us know about the cost and price strategy of the entity.

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For example, you might compare gross profit margin from one accounting period to another and see the difference. The difference could have come from two main reasons.

One is because of pricing strategy which means the marine are effect by increasing or decreasing prices. If management increases the price, then the margin will increase as well.

And if the management decrease price because they want to attack the competitors, then even the sales are increased, but the margin is low.

You can also use the figure of gross profit in the income statement to assess how good the cost controlling of the entity is.

For example, a decrease in gross profit in the income statement might be because of an increase in the cost of goods sold per unit of products could be because of an increase in labor cost, direct material, direct overhead, wastage, quality mater, and slow productions.

Does Gross Profit Show on the Balance Sheet?

No, gross profit is not shown in the balance sheet or other statements besides the income statement. In most cases, it shows the net income in the face of the income statement and the net income link to the note, breaking down the gross and other contra accounts like commission or discount.

Therefore, you can not calculate the gross or gross profit on the balance sheet.

What is the Different Between Gross Profit and Net Profit?

Gross profit is the profit that the entity generates during the period by deducting the direct cost including the cost of products which we call the cost of goods sold, and the cost of services. These profits do not consider administrative costs, finance costs, and corporate tax expenses. On the other hand, net profit is the company’s profit during the period by considering administrative costs, finance costs, and corporate tax expenses.

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