Your gross profit is basically a way to calculate whether you’re spending more to create goods and services than you make by selling them.
You calculate your gross profit by taking your total revenue (money made through business activity) and subtracting the costs of making your products (including the cost of any labour). These costs are known as your cost of goods sold (COGS).
Gross profit = Revenue - Cost of goods sold (COGS).
If that number is positive, great! But if that number is negative, or is lower than you need it to be, you may need to rethink how you create your products/services.
Gross profit example
Let’s say you’re a nine-year-old girl selling lemonade at a two-day event. Your COGS would include things like lemons, water, sugar, cups, and an hourly wage for the time you spend making and selling your wares.
For this example, let’s say each cup costs $0.15 to make, and you sell each cup for $1.
If you managed to sell 1,000 cups across two days, your profit would be their revenue ($1,000), minus the cost of making your product ($0.15 a cup).
- $1000 x 0.15 = $150
- $1,000 - $150 = $850
But wait, we’re still not done! You haven’t factored in your hourly wage of $15 (pretty good for a nine-year old!). If you spent four hours brewing and packing your lemonade, and then another 10 hours selling it at your stall, the cost of 14 hours of labour would be $210.
- $850 - $210 = $640 ← your gross profit!
Other types of business profit
Gross profit is a good way to see how profitable your products/services are. It shows how efficiently your business can produce and sell its products and services. A higher gross profit margin (gross profit divided by revenue, expressed as a percentage) generally indicates better efficiency and profitability.
It’s important to note that gross profit doesn’t take into account other operating expenses, like rent, internet bills, marketing expenses, and other overhead costs. If you’re interested in including these costs in your profit equation, you might want to look at your operating profit instead.
Similarly, if you want to know what your business’ “take home pay” is, you’ll need to calculate your net profit.
📖 For more information on the different types of business profit, and how to calculate them, check out our guide to growing profit for sole traders!
