Gross profit is the profit after eliminating products or services cost of goods sold from the total net sales. These profits are recording in income statement of entity and it is not records in the balance sheet.
Gross profit is not what the net earning for the company, but it is what the gross earning that entity received after deducting the direct cost ( cost of goods sold) like raw material, direct labor, and direct overhead.
For example, if the cost of phone 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 consider the cost of labor or management fee that occur for purchasing the phone, selling the phone, and any other cost like office rental fee.
How to calculate?
In income statement, gross profit shown the the line below cost of goods sold. In most of the case, it stay in the third line in income statement. If you are preparing your income statement, you can calculate your gross profit by
Gross Profit = Revenues – Cost of goods sold.
- Revenue here sometime called sales revenue, net sales or revenue. It is the total sales that entity generate during the specific period of time.
- Cost of goods sold here is the cost that entity spend on the products or service that they generate about. Remember, the cost that report here are the cost for goods that sold about only. The cost that incur and not related to products above should not report here.
Analyzing Gross Profit
Gross profit is very importance figure for users, shareholders, investors and management of entity. This profit also let us know about the cost and price strategy of entity.
For example, you might compare gross profit margin from one accounting period to another and you might see the different. The different could be come from two main reasons.
One is because of pricing strategy which mean the marine are effect by increasing or decreasing price. If management increasing price, then the margin will be increase as well.
And if the management decrease price because they want to attack the competitors, then even the sales is increased, but the margin is low.
You can also use the figure of gross profit in income statement to assess how good the cost controlling of entity is.
For example, decreasing of gross profit in income statement might because of increasing in the cost of goods sold per unit of products could because of increasing in labor cost, direct material, direct overhead, wastage, quality mater, and slow productions.