Gross profit formula, its definition, and why it matters for your busines

Understanding your business's profits is key to its success, which is why it’s so important to know how to calculate gross profit. By mastering the ins and outs of gross profit, you'll be equipped to make smart decisions that can boost your company's performance — especially in the ever-changing market.

We’ll break down the formula for gross profit and help you understand why it’s so important. Let’s demystify this metric so you can worry less about keeping up with a running list of money management tips and more about innovating your products, serving your customers, and ultimately growing your business.

What’s gross profit?

Gross profit is the money your business makes after subtracting all the costs related to manufacturing and selling your products or services. Think of gross profit as a financial pulse check that reveals the efficiency of your production processes and your product's market viability.

What’s the gross profit formula? 

The formula for gross profit is: gross profit = revenue - cost of goods sold. It's pretty straightforward, but let's break down the components. 

• Revenue: This is the total income your business generates from sales before any expenses. It doesn’t account for the costs of running your business, like taxes, interest, and operation.

• Cost of goods sold (COGS): This includes all direct costs attributed to the production of goods sold by your company. Examples of COGS are raw materials needed for manufacturing purposes, wages paid to employees, shipping costs for transporting materials, time spent on client services, utilities for your production site, etc. 

How to calculate gross profit

To calculate gross profit, start by determining your business's revenue in a specific period. Then, calculate the total cost directly associated with producing the goods sold in the same timeframe. Subtract the latter from the former, and voilà, you have your gross profit!

Why is gross profit so important for your business? 

Gross profit is important for your business because it acts as a clear indicator of how well your business is performing in the most fundamental way. When you have a steady and healthy gross profit, it usually means your production methods are working and your products are doing well in the market. 

It’s also important to keep an eye on how your gross profit changes over time. This helps you make big decisions about the future of your business, like whether to expand, shift focus, or make improvements. In this same vein, tools like Expensify are super handy when it comes to managing spend and monitoring trends accurately. Using them helps you make choices based on solid data rather than gut feelings.

What’s a good gross profit percentage? 

A "good" gross profit percentage can vary greatly depending on the industry in which your business operates. For instance, goods-producing industries like retailers, restaurants, and manufacturers might consider a gross profit margin of 50% to 70% healthy. However, this standard doesn't apply universally.

Service industry companies like financial institutions, legal firms, and tech businesses often operate with significantly higher gross profit margins — sometimes in the high 90% range. This is largely due to their lower production costs than companies producing physical goods.

On the other end of the spectrum, industries like retail might see gross profit percentages on the lower side, ranging from a modest 3% to 13%. It really depends on what your business does and what kinds of products or services you’re producing. 

To gauge whether your business is truly in a healthy place, you should also consider other key indicators: 

• Are you maintaining a positive cash flow, indicating that your business is generating more money than it's spending? 

• Can you comfortably pay your employees a fair wage without financial strain? 

• Do you have sufficient funds set aside for emergencies or unexpected downturns? 

• Is your business generating enough profit to reinvest in growth opportunities? 

If you can answer “yes” to these questions, it's a strong sign that your business is not only surviving but also thriving.

What’s the difference between gross profit and net profit?

The difference between gross profit and net profit lies in the costs deducted from revenue. Essentially, gross profit tells you how much money you make just from selling your products, while net profit shows what's left after paying all your business expenses. 

Gross profit is calculated by subtracting the cost of goods sold from total revenue, giving you a look at the profitability of your core products or services. 

Net profit, also known as the bottom line, is determined by subtracting all expenses, including operating expenses, taxes, interest, and depreciation, from the gross profit. 

Simplify your money management with the right tools

As a small business owner, managing finances, nailing down a pricing strategy, and calculating gross profit can seem overwhelming. However, a suite of effective tools can streamline this process, allowing you to concentrate on expanding your business rather than getting bogged down in numbers. Consider incorporating a mix of the following resources to keep your financial management efficient and accurate:

• Expense management software: Expense management apps are ideal for tracking spending, effortlessly creating expense reports, cataloging eReceipts, and ensuring precise gross profit calculations.

• Accounting systems: Choose from a range of accounting solutions to automate bookkeeping, manage invoices, and monitor financial health. If you want to make your day-to-day even easier, consider accounting software that integrates with your expense management apps. 

• Budgeting tools: Consider user-friendly budgeting apps to keep a tight rein on your expenses, forecast future spending, and ensure your finances stay on track.

By integrating these tools into your financial toolkit, you can maintain a comprehensive overview of your business’s fiscal landscape while keeping your focus on growth and innovation. Also, don’t forget to run a situational analysis. This step is crucial for understanding how changes in the market, industry trends, and other external factors may impact your gross profit and overall business performance.

Turn gross into great with Expensify 

Getting the hang of gross profit and understanding its implications can transform your business strategy. With Expensify's automated platform, monitoring gross profit becomes way easier — and more accurate — by allowing you to make informed decisions that drive growth, optimize operations, and improve your bottom line.