What Are the Advantages of Using Gross Profit and Why Is It Important?
Your gross profit measures the efficiency in how your business uses its variable expenses (costs that fluctuate), such as labor, raw materials and supplies.
Here are examples of factors that affect your gross profit:
- Product/service adjustments
- Raw materials costs increase
- Shipping rates decrease
- Credit card fees increase
- Sales team commission structure changes
What Are the Limitations of Gross Profit?
- Not Granular: You need to monitor the individual cost accounts under your cost of sales to understand the drivers of your gross profit.
- Less Effective for Service Businesses: For companies without a detailed goods production process, the gross profit is the same as the total sales (not sales), so it’s less effective—than at businesses selling goods—in measuring financial efficiency.
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Important Gross Profit Ratios
Your gross profit ratios are some of the most important
financial ratiosyou need to monitor.
Here is how you calculate them:
Gross Profit Ratio
Gross Profit Ratio = (Gross Profit / Cost of Sales) x 100
Gross Profit Margin Ratio
Gross Profit Margin Ratio = (Gross Profit / Cost of Sales) / Gross Profit
The higher your percentage/ratio is, the more efficient your business is.
What is the Difference Between Gross Profit and Gross Profit Margin?
Gross profit is the difference between your net sales and your cost of sales.
Gross profit margin is the percentage of your net sales that exceeds your cost of sales.
Gross Profit vs. Net Income: What Are the Differences?
Gross profit subtracts only your cost of sales (the costs attributed to producing your sales) from your net sales.
Net income subtracts your cost of sales and all other operating expenses from your net sales.
Gross Profit: The Bottom Line
How efficient is your business? And can you improve your profitability? Monitor your gross profit and its increases or decreases against your cost of sales.
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