What is Gross Profit and How Do You Calculate It?

Gross profit is calculated as:

Gross Profit = Revenue − Cost of Sales (Cost of Goods Sold)

The exact makeup of “cost of sales” depends on the business model.

What counts as cost of sales

Cost of sales typically includes costs directly tied to producing or delivering what you sell, such as:

• Raw materials and components
• Direct labour involved in production or delivery
• Manufacturing overheads directly related to output (in some cases)
• Packaging and freight-in (depending on accounting policy)
• Subcontractor costs that are directly attributable to revenue
• Inventory movement (opening stock + purchases − closing stock) for product businesses

For service businesses, cost of sales might include:

• Contractor/freelancer fees tied to projects
• Billable staff time (if tracked that way)
• Hosting or delivery costs directly linked to the service

Costs like general admin salaries, rent for head office, general software subscriptions, or broad marketing are typically operating expenses, not cost of sales.

Why gross profit matters

Gross profit helps you understand:

• Whether pricing covers direct delivery costs
• Whether production or delivery efficiency is improving
• Which products or services are genuinely profitable
• How much is left to pay overheads and still make a net profit

Gross profit is often paired with gross profit margin, which expresses gross profit as a percentage of revenue:

Gross Margin = (Gross Profit ÷ Revenue) × 100

A falling gross margin can signal rising supplier costs, discounting, shrinkage/waste, or misclassification of costs.

Common causes of “wrong” gross profit

Gross profit can be distorted by:

• Incorrect inventory valuation or stock counts
• Posting direct costs to overheads (or vice versa)
• Timing issues (costs recorded in a different period than related sales)
• Not accounting for returns, rebates, or discounts accurately

Regular review of cost coding and inventory processes is a practical way to keep gross profit meaningful.

What’s the difference between gross profit and net profit?

Gross profit is revenue minus direct costs. Net profit is what remains after all expenses, including overheads, interest, and taxes(depending on the profit line you’re using).

Can gross profit be negative?

Yes. If cost of sales is higher than revenue (for example due to pricing issues, wastage, or incorrect cost allocation), gross profit can be negative.

Why is gross margin important?

Gross margin shows how much of each pound/euro of sales is left after direct costs to cover overheads and profit. It’s a key indicator for pricing and sustainability.

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