How to calculate gross profit
Gross profit is revenue minus cost of goods sold. Learn the formula, worked examples and how to use it.
Published Monday 17 August 2026
Table of contents
How to calculate gross profit
Key takeaways
- Gross profit is your revenue minus cost of goods sold (COGS), and it shows how much you keep after covering the direct costs of delivering your product or service.
- The formula is simple: Revenue - COGS = Gross profit. You can calculate it for any period using figures from your profit and loss report.
- Gross profit is different from net profit. Gross profit covers only direct costs, while net profit accounts for all your expenses including rent, salaries, and taxes.
- Tracking gross profit regularly helps you spot pricing problems, rising costs, and margin trends before they become serious issues.
What is gross profit?
Gross profit is the money your business earns after subtracting the direct costs of producing or delivering your goods and services. It's one of the most important numbers on your profit and loss report, because it tells you whether you're making enough on each sale to cover your other expenses and still turn a profit.
Think of it this way: if you sell handmade candles for $25 each and the wax, wicks, jars, and labour cost you $10 per candle, your gross profit is $15 per candle. That $15 is what you have left to pay for things like rent, marketing, insurance, and your own salary.
For small business owners, gross profit is a useful health check. A healthy gross profit means your pricing and production costs are in good shape, while a shrinking gross profit is an early warning sign that something needs attention, whether that's rising supplier costs, underpricing, or inefficiencies in how you deliver your service.
Why gross profit matters
Gross profit tells you whether your core business activities are profitable, before overheads like rent and admin come into play. It sits near the top of your profit and loss statement, directly below revenue, so it's the first signal of whether your pricing and direct costs are working.
Watching gross profit closely gives you a few practical advantages:
- Pricing confidence: you can see whether each sale earns enough to cover the rest of your costs
- Early cost control: a falling figure flags rising supplier or production costs before they hit your bottom line
- Better decisions: you can compare products, services, or periods and put effort where it pays off
Gross profit formula
The gross profit formula is straightforward. Once you know your total revenue and your cost of goods sold, you can calculate gross profit in seconds.
Gross profit = Revenue - Cost of goods sold (COGS)
Here's what each part means:
- Revenue is the total income your business earns from selling goods or services during a specific period, before any deductions. You might also see this called ‘sales’ or ‘turnover’ on financial reports
- Cost of goods sold covers all the direct costs tied to producing or delivering what you sell. For a product business, COGS typically covers raw materials, production labour, and shipping. For a service business, it includes the direct labour and materials needed to deliver the service
COGS does not include indirect expenses like office rent, marketing, utilities, or administrative salaries. Those get subtracted later when calculating net profit.
How to calculate gross profit step by step
Calculating gross profit takes just a few steps. Here's how to do it, whether you're pulling numbers from your accounting software or working from a simple spreadsheet.
1. Determine your revenue
Start by adding up all the income your business earned from sales during the period you're measuring. This could be a month, a quarter, or a full year. Include all sales of products or services, but leave out non-operating income like interest earned or one-off asset sales. If you use Xero, you can find your total revenue on your profit and loss report, calculated automatically from your invoices and sales transactions.
2. Calculate your cost of goods sold (COGS)
Next, add up all the direct costs involved in producing or delivering your products and services during the same period. Common COGS items include:
- Raw materials and supplies
- Direct labour, meaning wages for employees who make or deliver the product
- Manufacturing or production costs
- Freight and shipping for inventory
- Packaging materials
If you run a service business, your COGS might include the wages of staff who deliver services, software licenses used in delivery, or subcontractor fees. The key question is whether the cost would disappear if you stopped selling. If it would, it's likely part of COGS.
3. Subtract COGS from revenue
Now apply the gross profit formula. Take your total revenue and subtract your total COGS. The result is your gross profit for that period.
For example, if your business earned $120,000 in revenue last quarter and your COGS was $45,000:
$120,000 - $45,000 = $75,000 gross profit
4. Interpret the result
A positive gross profit means you're earning more from sales than it costs to produce what you sell. That's a good sign, though it doesn't mean you're profitable overall, because you still need to cover operating expenses, taxes, and other costs.
If your gross profit is negative or very low, it usually means your pricing is too low, your production costs are too high, or both. That's a signal to review your pricing and look for ways to reduce direct costs. Tracking gross profit over time is more valuable than looking at a single number, so compare it month over month or quarter over quarter to spot trends early.
Gross profit calculation examples
Seeing the formula in action makes it easier to apply to your own business. Here are two examples covering different business types.
Product business example
Sarah runs a small online store selling custom phone cases. In March, she sold 500 cases at $30 each, bringing in $15,000 in revenue. Her COGS for the month included $4,000 in materials, $2,500 in direct labour, and $500 in shipping supplies.
Revenue: $15,000
COGS: $4,000 + $2,500 + $500 = $7,000
Gross profit: $15,000 - $7,000 = $8,000
Sarah's gross profit of $8,000 means she kept about 53% of her revenue after covering direct costs. That $8,000 needs to cover her website hosting, marketing, insurance, and other overhead.
Service business example
Tom runs a small landscaping company. In April, he earned $22,000 from client jobs. His COGS included $6,000 in crew wages for time spent on jobs, $2,000 in fuel and equipment maintenance, and $1,000 in supplies like mulch and fertiliser.
Revenue: $22,000
COGS: $6,000 + $2,000 + $1,000 = $9,000
Gross profit: $22,000 - $9,000 = $13,000
Tom's gross profit of $13,000 gives him a solid foundation to cover his truck payments, office expenses, insurance, and his own salary.
How to calculate gross profit margin
Gross profit is a dollar amount, but gross profit margin turns it into a percentage so you can compare performance across periods or against other businesses. It answers a simple question: how much of every sales dollar do you keep after direct costs?
The gross profit margin formula is:
Gross profit margin = (Gross profit ÷ Revenue) × 100
Using Sarah's phone case business from the earlier example, where gross profit was $8,000 on $15,000 of revenue:
Gross profit margin = ($8,000 ÷ $15,000) × 100 = 53.3%
This means Sarah keeps about 53 cents of every dollar in revenue after paying for materials, labour, and shipping. The remaining 47 cents covers her direct production costs.
Gross profit vs gross profit margin
Gross profit and gross profit margin are related but measure different things. Gross profit is a dollar figure, while margin is the percentage of revenue you keep after direct costs.
The distinction matters when you compare businesses of different sizes. A business earning $1 million with a 20% margin keeps less per dollar of revenue than a business earning $200,000 with a 50% margin. The dollar amount tells you the scale of your profit, and the gross profit margin tells you how efficiently you turn revenue into profit.
What is a good gross profit margin?
A good gross profit margin depends heavily on your industry, so there's no single target that fits every business. As a general guide, retail businesses often see margins between 25% and 50%, while service businesses can reach 50% to 70% or higher because their direct costs are lower.
Benchmarks vary widely by sector. Recent 2026 analysis from Bluevine shows software businesses average around 71% gross margin, while food wholesalers average closer to 15%. The most useful benchmark is your own trend over time, compared against businesses of a similar size in your sector rather than a broad average.
Gross profit vs net profit
Gross profit and net profit both appear on your profit and loss report, but they answer different questions about your business. Gross profit shows how much you earn after direct costs, while net profit shows what's left after every expense.
Net profit subtracts all your costs, including operating expenses such as rent, utilities, marketing, and salaries, plus interest and taxes. It tells you how much your business actually earned at the end of the day. Here's a quick comparison:
- Gross profit = Revenue - COGS
- Net profit = Revenue - COGS - operating expenses - interest - taxes
A business can post a strong gross profit but a low or negative net profit if its overheads are too high. When that happens, the issue is your operating expenses rather than your pricing or production costs, and knowing where the gap sits helps you fix the right problem.
What affects your gross profit?
Several factors can push your gross profit up or down. Understanding them helps you make better decisions about pricing, sourcing, and operations.
- Changes in COGS: if suppliers raise prices or you switch to higher-quality materials, your costs go up and gross profit falls, even when sales stay the same
- Pricing adjustments: raising prices increases revenue without changing COGS, which lifts gross profit, though pricing too high can reduce sales volume
- Sales volume: selling more units can improve gross profit, especially with bulk discounts on materials or more efficient production at higher volumes
- Production efficiency: streamlining how you make or deliver your product reduces waste and direct labour, improving gross profit without changing prices
- Supply chain disruptions: delays, tariffs, or shortages can raise your cost of sales unexpectedly, so backup suppliers or fixed-price contracts help protect your margins
How to improve your gross profit
If your gross profit isn't where you'd like it, there are practical steps you can take. Learning how to measure profitability starts with moving this number in the right direction.
- Review your pricing: check whether your prices reflect the true cost of delivering your product or service, and adjust if costs have risen but prices haven't
- Negotiate with suppliers: ask for volume discounts, longer payment terms, or alternative suppliers, since even small reductions in material costs add up over a year
- Reduce waste: look at your production process for inefficiencies, such as overordering materials or avoidable scrap and rework
- Focus on higher-margin work: if some offerings have better margins than others, put more sales and marketing effort behind them
- Track your numbers regularly: review gross profit monthly rather than only at tax time, so you can catch a downward trend early and respond
Track your gross profit with Xero
Knowing how to calculate gross profit is the first step, and keeping track of it consistently is what helps you make smarter decisions over time. Xero's cloud accounting software pulls your revenue and cost of goods sold into a clear profit and loss report automatically, so you always know your gross profit without crunching the numbers yourself.
You can run reports anytime, compare periods side by side, and spot trends before they become problems. Start with Xero and get one month free.
FAQs on gross profit
Here are answers to some frequently asked questions about gross profit.
What is a good gross profit margin for a small business?
A good margin depends on your industry, with retail often between 25% and 50% and service businesses ranging from 50% to 70% or higher. Track your margin over time and compare it to similar businesses in your sector.
What is included in gross profit?
Gross profit includes your total revenue minus the direct costs of producing or delivering what you sell, such as materials, production labour, and freight. It excludes overheads like rent, marketing, and admin salaries, which are counted later as operating expenses.
Can gross profit be negative?
Yes. A negative gross profit means your cost of goods sold is higher than your revenue, which usually signals a serious pricing or cost problem that needs immediate attention.
How often should I calculate gross profit?
Monthly is ideal for most small businesses, giving you enough data to spot trends without daily noise. If your business is seasonal, comparing the same month year over year can be especially helpful.
Does gross profit include employee salaries?
Only if those employees are directly involved in producing or delivering your product or service. A factory worker's wages are part of COGS, while your office manager's salary is an operating expense subtracted when calculating net profit.
What's the difference between gross profit and gross income?
In most small business contexts, gross profit and gross income mean the same thing: revenue minus cost of goods sold. Some tax forms and accounting standards use the terms slightly differently, so check with your accountant if you need to report one specifically.
Related terms
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Disclaimer
This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.