Gross Profit

I have added gross profit in Accounting Glossary because gross profit is the accounting term. In simple words, gross profit is excess of sales over cost of goods sold. If we deduct total cost of goods sold before adding other indirect expenses from total sales of company, it will be gross profit of company.

Gross profit Formula

Gross Profit = Total Sales  - Cost of Goods sold

Note :

a) Total sales = cash sales + credit sales - sales return

b) Cost of Goods Sold = Opening stock + purchase + direct expenses - closing stock.

Importance of Gross Profit

1. Helpful for taking major decisions

After calculating gross profit, company can take major decisions.

a) Is current gross profit perfect?

b) Is there any possibility to increase the gross profit?

c) Is this amount is better than previous or not?

2. Gross Profit Ratio Analysis

Gross Profit Ratio = Gross Profit / Sales X 100

By studying this ratio, company manager can analyze following questions:

a) Is actual gross profit ratio is more than standard gross profit ratio?

This is the first question, which we can not solve without getting real figure of gross profit and gross profit ratio. It is very easy to make any standard gross profit ratio. Suppose, I can estimate gross profit ratio 20%. It is easy to estimate but if real gross profit ratio is less than this, then our other planning may affected from this. First of all our net profit rate will affected and then market value of company. So, we can check the variance of gross profit ratio only after calculating gross profit ratio.

b)  How to establish correlation between sales prices and demand of product?

We have read in economics that there is opposite relationship between sales prices and demand of products. Gross profit ratio analysis will be helpful to establish relationship between demand and prices of sales revenue.  Company can apply following strategy.

i) Calculate current gross profit ratio.

ii) Increase the prices for one month and again check the gross profit ratio.

iii) Decrease the prices for next month than previous month and again check the gross profit ratio.

This indicates clearly that company is interested in experiment and this analysis will reach at that position where company can decide optimum price for his products for continue demand and at this level company will gain better GP ratio.

c) What is trend of Gross profit of Company?

Every year calculation teaches company about the trend of gross profit of company. Company should check this trend also by check previous years gross profit data.