Definition of gross profit: gross profit is a measure of profit calculated by deducting direct costs (also known as cost of goods sold) from revenue.
What is gross profit?
Gross profit is usually show in the middle of the income statement, and represents the profit after deducting the costs which directly generated the revenue.
Gross profit gives a good measure of the incremental profit generated by the business for each additional sale made.
Gross profit expressed as a percentage of revenue is called gross margin.
Gross profit is also the level at which businesses can measure the profitability of individual products to assist core business decision-making.
If a product or service generates a gross loss, i.e. the direct costs exceed the revenue from the product, then the company should not offer the product or service, as increasing sales would only increase the loss.
If a product or service generates a gross profit, this opens the doorway to the business offering it. However, to maximise gross profit, a company should focus on the products which offer the highest gross profit, rather than selling anything which would generate a positive figure.
Ultimately a company has finite resources, such as shelf space, factory capacity or restaurant locations, so it needs to be selective as to which products and services it offers. Ranking products by gross profit and gross margin is one way to do this.
Find out more about analysing the profitability of individual product lines in the best management accounting books.
Gross profit is not a guarantee of overall profitability. This is because the total gross profit needs to cover overheads, finance & tax costs before the business as a whole delivers a net profit at the bottom line.
How is the phrase gross profit used in a sentence?
“The company is in rude financial health, with a strong balance sheet and gross profit coming out of its ears!”
“The company’s strongest asset is its healthy gross profit, which has remained high despite a softening of revenue.”
How does the definition of gross profit relate to investing?
Gross profit is a key performance indicator which investors use to understand if a business is successfully driving high sales and keeping its direct costs under control.
If a business is unable to increase gross profit; either through revenue growth or cost-cutting, then it may be forced to cut back-office costs or overheads to try and protect its profitability at the bottom line.