Gross profit is a measure of profitability. It is the amount of profit a business makes after deducting all the costs of associated with delivering a service or product sold.
Gross Profit = Turnover – Direct Costs
An Example of Gross Profit
Here is an income statement the first three lines of which represent the calculation of gross profit.
In the below Example Accounts has sales of £250,000 and £65,000 worth of costs meaning their gross profit is £185,000.
Why is Gross Profit Important?
Understanding gross profit is vital for business owners because it is a measure of how much profit is made to pay for overheads. If a business is unable to pay overheads it raises questions over the long term sustainability of the business – if a business can’t make enough to pay for things like rent or salaries perhaps it is just not a valid business.
How Can You Increase Your Gross Profit?
Gross profit is a measure of profitability and efficiency of a business in delivering its product or service. To increase profit you need to address the two elements that make up its calculation – sales pricing and costs (or even a combination).
Increasing Sales Price
Increasing the price you sell will increase your gross profit because your costs stay the same but charge more for it. Obviously increasing pricing can make you uncompetitive in the market place or put your existing customer off, so this should be approached with caution.
Decrease Cost Prices
A review of you cost base could show that you are paying too much to your suppliers. Perhaps you can negotiate supplier discounts, bulk buy or even find new suppliers which save you money and filters straight into your gross profit.
Anita is a Chartered Accountant with over a decade of experience taking self employed business owners from financially confused to business savvy.
She is the creator of the ‘Go Self Employed’ website, which her corner on the internet where she makes self employment less terrifying.