The gross profit is the total revenue subtracted by the cost of generating that revenue. In other words, gross profit is sales minus cost of goods sold. It tells you how much money a business would have made if it didn’t pay any other expenses such as salary, income taxes, office supplies, electricity, water, rent, etc.
When you look at an income statement, GAAP rules require that gross profit be broken out and clearly labeled as its own line so you can't miss it. Still, you should know how to calculate it for yourself so here is the formula:
Total Revenue - Cost of Goods Sold (COGS) = Gross Profit
The gross profit figure is important because it is used to calculate something called gross margin, which we will discuss in a moment. In fact, you can't really look at gross profit on its own and know if it is "good" or "bad", making the gross margin even that much more important.
An Example of Gross Profit from One of My Companies
To help illustrate the concept of gross profit, I'll give you an example from one of the businesses in which I have a substantial ownership stake. The company is called Kennon Home Accessories. It sells a lot of luxury shaving sets both online and through its flagship retail store just north of Kansas City. If a customer purchases an imported British luxury shaving set for $315, our cost of goods sold would typically be $160 for the set itself, $20 for various merchant fees, service charges, and bank processing costs, and $20 for shipping and handling into our retail store.
This results in revenue of $315 - cost of goods sold of roughly $200 for a gross profit of $115 per every shaving set sold. If we were to drop the price 20% for a sale, the calculation would change to $252 revenue - $200 costs of goods sold = $52 gross profit. The $115 in the first case, or the $52 in the second, is the money we have available to pay our sales associates, taxes, office supply expense, and computer costs. The higher the gross profit, the more money we have for expansion, salaries, or dividends to shareholders.
