What is gross profit?

In plain English

Gross margin is gross profit divided by revenue. A falling margin can signal rising costs or underpricing.

It does not include overhead like rent.

Why it matters

Gross profit shows how much each sale leaves to pay for rent, salaries and everything else. If it is too thin, no amount of overhead cutting will fix the business. Watching it month to month alerts you to supplier price increases, discounting or waste before they eat into the bottom line.

It only works if costs are sorted correctly. Lumping direct costs with overhead makes gross profit look higher than it is. Lenders and buyers often look at it first because it reveals how well the core offering is priced.

Worked example

Revenue $200,000 minus COGS $120,000 is $80,000, a 40% gross margin.

How to handle it

1. Make sure direct costs are recorded in cost of goods sold accounts and overhead is not.
2. Run the profit and loss and find the area line between cost of goods sold and operating expenses.
3. Divide gross profit by revenue to get gross margin, and track it each month in a spreadsheet.
4. Compare gross profit by product, service or job if your software supports classes, tags or projects.
5. Investigate any month where margin moves noticeably from its usual range.

Common mistakes

• Recording all costs as operating expenses, which makes the area equal revenue and tells you nothing.
• Expensing inventory purchases when bought, which swings the area up and down with purchasing timing.
• Comparing gross profit dollars across months without looking at margin, which hides price or cost changes.
• Leaving discounts or returns out of revenue, which overstates gross profit.

Not the same as: Net income

The area is revenue minus direct costs only. Net income is what remains after all expenses, including overhead, interest and taxes where they apply. See Net income.

Go deeper

• Cost of Goods Sold Explained for Small Business: What cost of goods sold includes, how to calculate it for products and services, and why getting it right matters for margins and taxes.
• Financial Ratios Small Business Owners Should Know: Learn the handful of financial ratios that matter for small businesses: margins, current ratio, debt, collection days, and how to read them.

Try it

Use the related free tool.

Related terms

• Income statement (profit and loss): A report of revenue and expenses over a period that shows net profit or loss.
• Inventory: Goods held for sale or materials used to make them, recorded as an asset until sold.
• Gross margin: Gross profit as a percentage of revenue.

Common questions

General information, not tax, legal or accounting advice. Confirm rules with the IRS, the NJ Division of Taxation or a licensed professional.