How To Calculate Gross Profit Margin

Your gross profit margin tells you whether your pricing and production costs make sense. For every dollar of net sales, it shows how much is left after paying the direct costs of the goods sold or services delivered – before rent, admin, marketing and other overheads. In other words, gross profit focuses on the cost of getting your product or service out the door, and the margin shows how well you’re doing that.

Below, we’ll cover the gross profit formula, the gross profit margin formula, what belongs in the cost of goods sold, and how to use these metrics to guide your pricing, cost management, and overall decision-making.

Gross profit vs gross profit margin

Both terms belong together, but they aren’t the same. Gross profit is a dollar amount. It’s the sales profit before your overheads. Whereas gross profit margin (or just ‘gross margin’) is a percentage. It shows what proportion of revenue you keep after production costs are accounted for.

Think of ‘gross profit vs gross profit margin’ as like ‘amount vs percentage’. Both are valuable because the amount tells you how much profit you generated, and the percentage lets you compare performance across products and time periods.

The gross profit formula that matters

Gross profit = Net sales – Cost of goods sold (COGS)

Use net sales (also called net revenue, i.e. total revenue minus returns, allowances, discounts, etc.), not gross/billed sales. Net sales better match reality.

Gross profit margin = (Gross profit ÷ Net sales) × 100

You can also write the gross profit margin calculation as:

(Net sales – COGS) ÷ Net sales × 100

Both get you to the same number by dividing gross profit by net sales.

What is cost of goods sold?

COGS are the costs involved in making or delivering your offer – costs that rise and fall with sales volume (variable costs). For a product business, that usually includes:

• Raw materials and material costs.
• Direct labour costs (wages for staff making the product).
• Freight-in and duty on materials.
• Consumables and packaging for production.
• Merchantable wastage and shrinkage (where applicable).

For a service business, your COGS could include:

• Subcontractor fees tied to a job.
• Billable wages/technicians on that job.
• Project-specific software or licences used only for delivery.

What’s not COGS? Operating expenses (the ‘overheads’ that keep the lights on) like rent, utilities, administrative costs, accounting, marketing and salaries. These are indirect costs and live below gross profit on your income statement.

Step-by-step example

Here’s a scenario to look at for a business that creates products. Let’s assume that you have net sales for the month of $120,000 and your COGS include:

• Raw materials: $38,000
• Labour: $22,000
• Packaging and freight-in: $5,000
• Total COGS = $65,000

In this example, you’d calculated gross profit like the following:

Gross profit = $120,000 – $65,000 = $55,000

So in order to get the gross profit margin, you’d do:

Gross profit margin = ($55,000 ÷ $120,000) × 100 = 45.8%

In other words, you keep 45.8 cents of the dollar after production costs to cover your operating expenses and eventually produce net profit.

Interpreting your gross profit margins (and acting on them)

• High gross profit margins (e.g. 50%+) signals strong pricing power, tight production control, or a premium offer. A high gross profit margin gives you much more room to absorb overheads and still deliver net income.
• Lower gross profit margins may indicate rising material costs, overtime, discounting, or inefficiencies. If margins fall, take a closer look at your production costs line-by-line.

Using gross profit for decisions:

• Pricing: If costs jump and you don’t adjust your price, you can expect those margins to erode. So a good idea is to simulate new prices using the gross profit margin calculation before changing price tags.
• Supplier and cost management: Negotiate material rates or change your freight terms to lift those margins. Small unit savings can compound very quickly.
• Product mix: Promote higher-margin SKUs or services to grow a blended margin.
• Operational productivity: Improve yields, reduce rework and schedule smarter to lower your direct production costs.

Gross profit vs operating profit vs net profit

Getting a complete look at your company’s profitability requires all three measurements:

1. Gross profit: Net sales – COGS

Gross profit measures the performance of your core offering before overheads.

2. Operating profit (EBIT): Gross profit – operating expenses

Think rent, admin wages, utilities, insurance, marketing costs. In other words, subtracting operating expenses. It shows you your day-to-day operational efficiency.

Operating profit margin = Operating profit ÷ Net sales × 100

3. Net profit: Operating profit – interest – taxes – other expenses + other sources (e.g. non-operating income)

Net profit margin shows you the share of sales that become bottom-line profits. Net income reflects everything – from finance costs and income taxes to one-offs. In other words:

Net profit margin = Net profit ÷ Net sales × 100

You’ll see all three on the company’s income statement. When people ask about ‘net income, gross profit and EBIT’, they’re moving down that ladder from top-line to bottom-line. None replaces the others. Instead, they give you a complete overview of your company’s financial health when used together.

5 pitfalls in gross profit calculations

1. Using total revenue instead of net sales: Always remove returns, allowances and discounts.
2. Misclassifying costs: Keep COGS separate from overheads. Putting marketing into COGS will distort your profit margins.
3. Forgetting freight-in or duties: If it’s necessary to get stock ready for sale, it belongs in COGS.
4. Mixing fixed and variable elements: For planning, separate your variable costs (that scale with volume) from fixed costs.
5. Comparing unlike businesses: A low-margin, high-volume wholesaler can be as healthy as a high-margin, low-volume boutique.

What’s a ‘good’ gross profit margin?

There’s no universal number. A good gross profit margin depends on things like your model, pricing strategy, sector norms and more. So while a software business might post high gross profit margins (70%+) because its COGS is light, a food retailer might run thin margins but ultimately come up trumps on volume.

Use your specific industry’s benchmarks to get to grips with what ‘good’ looks like. What matters most is improving your own margin without harming demand or quality.

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