Understanding what a good gross profit margin is, and how it varies by industry, is key to measuring profitability and making smarter business decisions. Gross profit margin is a useful tool for financial analysis, but it should not be the only instrument in your toolkit. Other financial metrics and operating qualities should also be QuickBooks considered to complete your analysis of a prospective investment.

How gross profit helps your business

This metric is essential for assessing a business’s overall profitability and efficiency, as it does not consider interest and taxes, which are factored into the calculation of net profit. To calculate the gross profit, you must subtract the cost of goods sold (COG) from the total revenue. The COG includes the direct costs of producing the goods or services, such as raw materials and labor. Once you have the gross profit, you can calculate the gross margin by dividing the gross profit by the net revenue. The gross margin is a percentage that indicates how much of the total revenue is left after covering the COG. This figure is important for understanding the company’s profitability and ability to cover fixed costs.

• Gross profit helps evaluate how well a company manages production, labor costs, raw material sourcing, and manufacturing spoilage.
• The financial and reputational damage from a lawsuit can be irreparable.
• A good gross profit margin typically starts around 30%, with high-margin industries like software aiming for 70% or more, while others like grocery may settle for less.
• For example, a car dealership in the automotive industry will have a much lower gross profit margin than a bank in the financial services industry.

Gross profit cost definitions and examples

This higher profit margin can be used to cover labor costs, non-operating expenses, taxes, interest, and other overhead expenses. A higher profit margin means that the company is able to keep a larger percentage of its revenue as profit after covering its variable costs. A business can improve its gross profit and overall profitability by managing variable costs and increasing sales revenue. Gross profit plays a pivotal role in financial analysis by serving as the foundation for another critical metric known as the gross profit margin. This metric is essential for assessing a company’s production efficiency over different time periods. It’s important to note that merely comparing gross profits from year to year or quarter to quarter can be deceptive, as gross profits may increase while gross margins decline.

Operating profit

By understanding and tracking gross profit, businesses can make smart changes to increase profits and overall growth. Gross profit measures the revenue a business earns after deducting the cost of goods sold. It’s an important metric for assessing how efficiently a business covers its production costs in relation to its total income from sales. Gross profit is the revenue left over after you deduct the costs of making a product or providing a service. You can find the gross profit by subtracting the cost of goods sold (COGS) from the revenue. For example, if a company had $10,000 in revenue and $4,000 in COGS, the gross profit would be $6,000.

In the three months to Dec. 28, 2024, Apple Inc. (AAPL) reported total net sales of $124.3 billion and cost of sales of $66.03 billion. Subtract the latter from the former and you are left with a gross profit (labeled “gross margin” here) of $58.28 billion. In its 2024 fiscal year, we can see the company registered $43.45 billion in revenue, costing $33.85 billion to produce. That leaves the company, as reflected in the third line of its income statement, with a gross profit of $9.6 billion. For investors, gross profit is used to compare the efficiency of similar companies.

• You also should keep an eye out for large changes over time — and especially for sudden jumps or drops.
• The calculation for the cost of goods sold includes the expenses directly related to producing your products or services (e.g., raw materials).
• Total revenue, often referred to as sales, is the total receipts from selling a firm’s goods or services to its customers.
• When a company’s gross profit margin is high, it means they’re good at keeping costs in check.
• The use of a gross profit calculator gives basis for the calculation of net profit.
• This metric helps businesses understand the profitability of their core operations before accounting for other expenses.

Modern thinkers suggest that profits compensate for the risk that entrepreneurs take on when starting a business. Others argue that profits arise from inefficient markets and imperfect competition. For a bookstore, that could include the costs of procuring the books sold, the shipping costs if they were bought online, and the wages paid to staff serving customers in the store. An ltd and B ltd are two close competitors bidding in an auction to win the contract of $10 million. One of the key conditions for any of them to win the auction is that their gross profit figure should not be above 10% of the size of the contract.

Understanding the financial health of a company is essential for investors. The gross profit margin is among the most important and useful financial metrics that give investors potentially game-changing information about a company’s profitability. Let’s dive into what gross profit margin is, why it’s important, and how to use it when analyzing a company’s performance. Operating profit—also known as earnings before interest and tax (EBIT)—is a company’s profitability before interest and taxes. Gross profit is merely the profit generated through the sale of goods or services, less COGS.

Net income, meanwhile, is a company’s actual profit or what it is left with after all expenses are subtracted from revenue. Some businesses may fail to include direct labor costs in their COGS. Labor that is directly tied to the production of goods should be considered part of the cost of goods sold. The formula focuses solely on the gross profit relationship between sales revenue and the direct costs of producing goods or services sold. For example, retail stores may have margins around 30-40%, while software companies often have 70% or more. Comparing your margin to industry averages helps understand performance.

By layering gross profit margin onto customer segmentation data, marketing teams can focus on high-value audiences. If certain demographics tend to purchase high-margin products, campaigns can be targeted to appeal specifically to them. Using gross profit data, sales teams can be trained to promote high-margin products or bundles. Incentives can be aligned with gross profit contributions rather than just revenue targets. For example, a sales bonus system might reward reps for closing deals with the highest profitability rather than the largest dollar value. While sales growth is important, it is not always synonymous with financial health.

Small Business

Margins influence almost every aspect of decision-making, from marketing budgets to hiring plans and financing strategies. Regular comparison with industry benchmarks can help a business evaluate its competitiveness and efficiency. One normal balance way to address that low NPM would be to reduce overhead costs and rent a smaller space. When both margins decrease, that could mean you need to cut expenses somewhere. If both margins increase, it could be because of a recent trend you can invest in.

Vertical (Common-Size) Analysis

The cost of goods is given by the difference between the sum of opening stocks, purchases, direct expenses, direct labour, and the sum of purchase returns and closing stocks. This figure can help companies understand whether there are any inefficiencies and if cuts are required to address them and increase profits. The gross margin is also a way for investors to determine whether a company is a good investment.

• Factors such as competition, market demand, and economic conditions can affect both the prices a business can charge and the volume of sales it can achieve.
• It shows how much money remains after covering direct production costs but before paying for other expenses.
• Gross profit is the amount a business has earned minus the direct costs of manufacturing.
• A business that sells a higher proportion of high-margin products will generally have a better gross profit than a business that primarily sells low-margin products.
• Beyond being a figure in a financial statement, it can become a powerful decision-making compass.

Gross Profit Margin Ratio vs. Net Profit Margin Ratio

It equips entrepreneurs and managers with the clarity needed to set smart prices, identify cost-saving opportunities, and focus resources where they will yield the highest returns. It also fosters discipline in operations—ensuring that efforts to grow don’t sacrifice financial health. Here, businesses calculate the direct cost of a product and add a markup to achieve a target gross profit margin. For instance, if a product costs $40 to produce and the desired margin is 50%, the selling price should be $80. Reallocating marketing and sales efforts toward high-margin products or services can lift the overall gross profit margin.

She holds a Bachelor of Science in Finance degree from Bridgewater State University and helps develop content strategies. It is defined as the surplus gain from a business activity or process. So, if measured in value, a person who invests $2 and makes it $5 by selling goods gains $3. Use ROI documents to demonstrate the business value you’re providing. Yes, a Gross Profit Margin Ratio can be negative if the cost of goods sold exceeds the revenue. This situation is usually a red flag, indicating significant inefficiencies or pricing issues.

Professional Services

Many businesses use estimates for certain costs, such as overhead or labor. If these estimates are not updated regularly to reflect current conditions, it can lead to inaccuracies in gross profit calculations. The formula focuses solely on the relationship between sales revenue and the direct costs of producing goods or services sold. Gross profit margin is also used by stock market analysts and individual investors to compare one company to another. If two companies prepare products that are similar and have a comparable price point, the gross profit gross profit margin will highlight any competitive advantages that one company has over the other. Revenue is the amount of money generated from sales of a company’s products and/or services during a specific time period (for example, a month or a quarter).

To ensure growth translates to higher profitability, gross profit margin must either be maintained or improved. A company’s portfolio can also impact its overall gross profit margin. Products with higher margins can elevate the company’s average margin, while those with thinner margins can dilute it.

• Gross profit might suggest strong performance, but companies must also consider “below the line” costs when analyzing profitability.
• They pay $80,000 per year for their hourly staff and $40,000 for goods like coffee beans and pastries.
• Are you trying to figure out how much money your business actually makes before covering expenses like rent, salaries, and marketing?
• That leaves the company, as reflected in the third line of its income statement, with a gross profit of $9.6 billion.
• Put simply, gross profit helps you get a more accurate picture of how well your business is maintaining its production profit margins.

How to Calculate Gross Profit Margin (With Formula and Example)

Costs are subtracted from revenue to calculate net income or the bottom line. Gross margin is the percentage of a company’s revenue that’s retained after direct expenses such as labor and materials have been subtracted. It’s an important profitability measure that looks at a company’s gross profit as compared to its revenue. Totaling these various outgoings and incomings leaves the company with a net income (labeled “net earnings” here) of $1.24 billion.

By layering gross profit margin onto customer segmentation data, marketing teams can focus on high-value audiences. If certain demographics tend to purchase high-margin products, campaigns can be targeted to appeal specifically to them. Using gross profit data, sales teams can be trained to promote high-margin products or bundles. Incentives can be aligned with gross profit contributions rather than just revenue targets. For example, a sales bonus system might reward reps for closing deals with the highest profitability rather than the largest dollar value. While sales growth is important, it is not always synonymous with financial health.

Small Business

Margins influence almost every aspect of decision-making, from marketing budgets to hiring plans and financing strategies. Regular comparison with industry benchmarks can help a business evaluate its competitiveness and efficiency. One normal balance way to address that low NPM would be to reduce overhead costs and rent a smaller space. When both margins decrease, that could mean you need to cut expenses somewhere. If both margins increase, it could be because of a recent trend you can invest in.

Vertical (Common-Size) Analysis

The cost of goods is given by the difference between the sum of opening stocks, purchases, direct expenses, direct labour, and the sum of purchase returns and closing stocks. This figure can help companies understand whether there are any inefficiencies and if cuts are required to address them and increase profits. The gross margin is also a way for investors to determine whether a company is a good investment.

• Factors such as competition, market demand, and economic conditions can affect both the prices a business can charge and the volume of sales it can achieve.
• It shows how much money remains after covering direct production costs but before paying for other expenses.
• Gross profit is the amount a business has earned minus the direct costs of manufacturing.
• A business that sells a higher proportion of high-margin products will generally have a better gross profit than a business that primarily sells low-margin products.
• Beyond being a figure in a financial statement, it can become a powerful decision-making compass.

Gross Profit Margin Ratio vs. Net Profit Margin Ratio

It equips entrepreneurs and managers with the clarity needed to set smart prices, identify cost-saving opportunities, and focus resources where they will yield the highest returns. It also fosters discipline in operations—ensuring that efforts to grow don’t sacrifice financial health. Here, businesses calculate the direct cost of a product and add a markup to achieve a target gross profit margin. For instance, if a product costs $40 to produce and the desired margin is 50%, the selling price should be $80. Reallocating marketing and sales efforts toward high-margin products or services can lift the overall gross profit margin.

She holds a Bachelor of Science in Finance degree from Bridgewater State University and helps develop content strategies. It is defined as the surplus gain from a business activity or process. So, if measured in value, a person who invests $2 and makes it $5 by selling goods gains $3. Use ROI documents to demonstrate the business value you’re providing. Yes, a Gross Profit Margin Ratio can be negative if the cost of goods sold exceeds the revenue. This situation is usually a red flag, indicating significant inefficiencies or pricing issues.

Professional Services

Many businesses use estimates for certain costs, such as overhead or labor. If these estimates are not updated regularly to reflect current conditions, it can lead to inaccuracies in gross profit calculations. The formula focuses solely on the relationship between sales revenue and the direct costs of producing goods or services sold. Gross profit margin is also used by stock market analysts and individual investors to compare one company to another. If two companies prepare products that are similar and have a comparable price point, the gross profit gross profit margin will highlight any competitive advantages that one company has over the other. Revenue is the amount of money generated from sales of a company’s products and/or services during a specific time period (for example, a month or a quarter).

To ensure growth translates to higher profitability, gross profit margin must either be maintained or improved. A company’s portfolio can also impact its overall gross profit margin. Products with higher margins can elevate the company’s average margin, while those with thinner margins can dilute it.

• Gross profit might suggest strong performance, but companies must also consider “below the line” costs when analyzing profitability.
• They pay $80,000 per year for their hourly staff and $40,000 for goods like coffee beans and pastries.
• Are you trying to figure out how much money your business actually makes before covering expenses like rent, salaries, and marketing?
• That leaves the company, as reflected in the third line of its income statement, with a gross profit of $9.6 billion.
• Put simply, gross profit helps you get a more accurate picture of how well your business is maintaining its production profit margins.

How to Calculate Gross Profit Margin (With Formula and Example)

Costs are subtracted from revenue to calculate net income or the bottom line. Gross margin is the percentage of a company’s revenue that’s retained after direct expenses such as labor and materials have been subtracted. It’s an important profitability measure that looks at a company’s gross profit as compared to its revenue. Totaling these various outgoings and incomings leaves the company with a net income (labeled “net earnings” here) of $1.24 billion.