How is gross profit calculated?

Gross profit is calculated by subtracting the costs of goods sold (COGS) from total sales revenue. This calculation provides a measure of the company's efficiency in managing its production costs and pricing strategy. Gross profit focuses specifically on the direct costs associated with producing goods or services sold by the company, allowing the business to assess its core profitability before considering other operational expenses.

The costs of goods sold include expenses like raw materials, direct labor, and manufacturing overhead directly tied to the production of the goods sold. By using total sales as the starting point and deducting these specific costs, businesses can determine how much money they have made from selling their products before accounting for overhead, administrative costs, and other expenses.

This approach is crucial for businesses because it helps highlight profitability at the product level and informs pricing and inventory management strategies. Understanding gross profit is vital for assessing financial performance, making informed business decisions, and evaluating ongoing operational efficiency.