Gross profit is sales minus cost of goods sold or cost of services. It is what is left over after a company has paid the direct costs incurred in making the product or delivering service. Gross profit must be sufficient to cover a business’s operating expenses, financing costs, and taxes with enough left over for some net profit.
Though most income statements follow the format of revenue minus COGS equals gross profit, a small but significant number of income statements put COGS or COS under a subhead called operating expenses. These income statements don’t show a gross profit line at all. Even when gross profit is not shown it is easy to calculate.
If our sample company has revenue of $8,000 and COGS of $7,000, the calculation is as follows:
(Excerpts from Financial Intelligence, Chapter 9 – The Many Forms of Profit)
How much gross profit is enough? That varies substantially by industry, and it’s likely to vary from one company to another even in the same industry. A company with larger revenues can thrive with a lower gross profit percentage than a smaller one. (That’s one reason why Walmart can charge such low prices.) To gauge your company’s gross profit, you can compare it with industry standards, particularly for companies of a similar size in your industry. You can also look at year-to-year trends, examining whether your gross profit is headed up or headed down.