How to calculate gross profit
Learn how to calculate gross profit with a simple formula, worked examples and industry margin benchmarks.
Published Monday 17 August 2026
Table of contents
How to calculate gross profit
Key takeaways
- Gross profit is revenue minus cost of goods sold (COGS), showing how much you earn from sales after covering direct production costs.
- To calculate gross profit, subtract your total COGS from your total revenue for a given period.
- Gross profit margin expresses this figure as a percentage, making it easier to compare performance over time and against industry benchmarks.
- A healthy gross profit doesn't guarantee overall profitability, since operating expenses, interest, and taxes still need to be paid from what remains.
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 (P&L) 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. 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.
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 minus 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 (COGS) includes all the direct costs tied to producing or delivering what you sell. For a product business, COGS typically covers raw materials, manufacturing 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. Revenue here means net sales, so subtract any returns, allowances, and discounts from your gross sales figure before proceeding.
Include all sales of products or services, but don't include non-operating income like interest earned or one-off asset sales. You'll find revenue on your income statement. If you use Xero, you can find your total revenue on your profit and loss report. It's 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. For retail businesses, you can calculate COGS using this formula: beginning inventory plus purchases minus ending inventory. Common COGS items include:
- Raw materials and supplies
- Direct labour (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 licences used in delivery, or subcontractor fees. The key question is: would this cost disappear if you stopped selling? If yes, 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 minus $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, but it doesn't mean you're profitable overall. You still need to cover your 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. This is a signal to review your pricing strategy and look for ways to reduce direct costs. Tracking gross profit over time is more valuable than looking at a single number. 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: $15,000COGS: $4,000 + $2,500 + $500 = $7,000Gross profit: $15,000 minus $7,000 = $8,000
Sarah's gross profit of $8,000 means she kept 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: $22,000COGS: $6,000 + $2,000 + $1,000 = $9,000Gross profit: $22,000 minus $9,000 = $13,000
Tom's gross profit of $13,000 gives him a strong foundation to cover his truck payments, office expenses, insurance, and his own salary.
Gross profit margin and benchmarks
Gross profit and gross profit margin are related but measure different things. Gross profit is a dollar amount showing what's left after covering direct costs. Gross profit margin is a percentage that shows what proportion of your revenue you keep after those costs.
The gross profit margin formula is:
Gross profit margin = (Gross profit / Revenue) x 100
Using Sarah's phone case business from the earlier example:
Gross profit margin = ($8,000 / $15,000) x 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 goes toward direct production costs.
Gross profit margin is especially useful for comparing performance across different time periods or against industry benchmarks. A business earning $1 million with a 20% margin is keeping less per dollar of revenue than a business earning $200,000 with a 50% margin. Here are typical gross profit margin ranges by industry:
- Professional services: 50–80%
- Software and technology: 60–80%
- Retail (general): 25–50%
- Restaurants and food service: 25–40%
- Manufacturing: 20–35%
- Grocery and supermarkets: 20–30%
The dollar amount of gross profit matters, but the margin tells you how efficiently you're turning revenue into profit.
Gross profit vs net profit
Gross profit and net profit both appear on your P&L report, but they answer different questions about your business.
Gross profit shows how much you earn after covering the direct costs of your products or services. It tells you whether your core business activities are profitable. Net profit shows what's left after you subtract all your expenses, including operating costs (rent, utilities, marketing, salaries), 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 minus COGS
- Net profit = Revenue minus COGS minus operating expenses minus interest minus taxes
A business can have a strong gross profit but a low or negative net profit if its overhead costs are too high. If that's the case, the issue isn't your pricing or production costs; it's your operating expenses. Knowing where the gap is 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 your suppliers raise prices or you switch to higher-quality materials, your COGS goes up and your gross profit goes down, even if your sales stay the same.
- Pricing adjustments: Raising your prices increases revenue without changing COGS, which directly boosts gross profit. But pricing too high can reduce sales volume, so it's a balancing act.
- Sales volume: Selling more units can improve gross profit, especially if you benefit from 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 costs, improving gross profit without changing your prices.
- Supply chain disruptions: Shipping delays, tariffs, or shortages can increase your COGS unexpectedly. Having backup suppliers or negotiating fixed-price contracts can help protect your margins.
How to improve your gross profit
If your gross profit isn't where you'd like it to be, 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. If your costs have gone up but your prices haven't, it's time for an adjustment.
- Negotiate with suppliers: Ask for volume discounts, longer payment terms, or explore alternative suppliers. Even small reductions in material costs add up over a year.
- Reduce waste: Look at your production process for inefficiencies. Are you overordering materials? Is there a way to reduce scrap or rework?
- Focus on higher-margin products or services: If some of your offerings have better margins than others, consider putting more sales and marketing effort behind them.
- Track your numbers regularly: Review your gross profit monthly, not just at tax time. Catching a downward trend early gives you more time to respond.
Limitations of gross profit
While gross profit is a valuable metric, it doesn't tell the whole story about your business's financial health. Understanding its limitations helps you use it alongside other measures for a complete picture.
Gross profit ignores overhead costs, interest, and taxes. A healthy gross profit can still go with a low or negative net profit if your operating expenses are high. You might be making good money on each sale but still struggling to pay rent, marketing costs, or loan repayments.
- Gross profit doesn't reflect cash flow: Profit on paper isn't the same as money in the bank. You can show a strong gross profit while waiting 60 days for customers to pay their invoices.
- It doesn't account for one-off costs: Unusual expenses like equipment repairs or legal fees won't show up in gross profit, but they still affect your bottom line.
- Industry comparisons have limits: A 30% gross profit margin might be excellent in grocery retail but concerning in professional services, so context matters.
Track your gross profit with Xero
Knowing how to calculate gross profit is the first step. Keeping track of it consistently is what helps you make smarter business 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. To see how Xero can simplify your financial reporting, get 80% off for your first 3 months.
FAQs on gross profit
Here are answers to some common questions about gross profit.
What is a good gross profit margin for a small business?
A good gross profit margin depends on your industry. Retail businesses often see margins between 25% and 50%, while service businesses can range from 50% to 70% or higher. The most important thing is to track your margin over time and compare it to similar businesses in your sector.
Can gross profit be negative?
Yes. A negative gross profit means your cost of goods sold is higher than your revenue. This 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. This gives you enough data to spot trends without being overwhelmed by daily fluctuations. If your business has seasonal patterns, 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, but your office manager's salary is an operating expense that gets subtracted when calculating net profit.
What is the difference between gross profit and gross income?
Gross profit is the standard term for revenue minus cost of goods sold. "Gross income" can mean different things depending on context; for individuals, it often refers to total earnings before any deductions. For business calculations, use gross profit. If a form asks specifically for gross income, check with your accountant to confirm what's required.
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.