What is gross profit?

Published Monday 22 June 2026

Table of contents

• What is gross profit?
• Gross profit formula
• How to calculate gross profit
• Gross profit vs. gross profit margin
• Gross profit vs. net profit
• What is a good gross profit margin?
• What affects gross profit?
• How to improve your gross profit
• Track your gross profit with Xero
• FAQs on gross profit

Key takeaways

• Gross profit is the revenue left after subtracting the cost of goods sold (COGS), and it shows whether your core business activities are profitable before accounting for overhead expenses.
• Tracking gross profit alongside gross profit margin helps you compare performance across time periods, product lines, and industry benchmarks so you can spot trends early.
• Improving gross profit often comes down to practical steps like negotiating supplier costs, adjusting pricing, and monitoring which products or services deliver the strongest returns.
• Reviewing your gross profit regularly, ideally monthly, gives you the financial clarity to make confident decisions about pricing, spending, and growth.

What is gross profit?

Gross profit is the amount of money your business keeps after subtracting the direct costs of producing your goods or delivering your services. You'll find it on your income statement (also called a profit and loss statement), sitting between your total revenue and your operating expenses.

Think of it as a measure of how efficiently your business turns sales into profit at the most basic level. If your gross profit is healthy, it means you're earning enough from each sale to cover the direct costs and still have money left over for rent, salaries, marketing, and other operating expenses.

For small business owners, gross profit is one of the clearest signals of whether your pricing and production costs are working in your favor. A declining gross profit can flag issues long before they show up in your bank balance.

Gross profit formula

The gross profit formula is straightforward. Subtract your cost of goods sold from your total revenue.

Gross profit = Revenue - Cost of goods sold (COGS)

Revenue is the total income from sales before any costs are deducted. COGS covers the direct expenses tied to producing or delivering what you sell. Here's what typically counts as COGS:

• Raw materials and inventory
• Direct labor costs (wages for staff who make or deliver the product)
• Manufacturing supplies
• Shipping and freight for materials
• Packaging costs

COGS doesn't include indirect expenses like office rent, marketing, insurance, or administrative salaries. Those fall under operating expenses and come into play when you calculate net profit.

How to calculate gross profit

Putting the formula into practice helps it stick. Here are 2 examples showing how different types of businesses calculate gross profit.

1. Product business example: a bakery

Say you own a bakery and your monthly revenue from bread, pastries, and custom cakes totals $25,000. Your COGS for the month includes:

• Flour, sugar, butter, and other ingredients: $7,000
• Wages for your 2 bakers: $5,000
• Packaging materials: $500

Your total COGS is $12,500. Using the formula:

$25,000 - $12,500 = $12,500 gross profit

That $12,500 is what's left to cover your rent, utilities, marketing, and other overhead costs.

2. Service business example: a consulting firm

Now imagine you run a small consulting firm. Your monthly revenue from client projects is $40,000. Your COGS includes:

• Consultant salaries (billable staff): $18,000
• Software licenses used on client projects: $2,000
• Travel expenses for client site visits: $1,500

Your total COGS is $21,500. Using the formula:

$40,000 - $21,500 = $18,500 gross profit

Service businesses often have lower COGS than product businesses because there's no physical inventory, but direct labor costs tend to make up a larger share.

Gross profit vs. gross profit margin

Gross profit and gross profit margin are related but tell you different things. Gross profit is a dollar amount. Gross profit margin is a percentage that shows what portion of each dollar in revenue you keep after covering direct costs.

Here's the formula for gross profit margin:

Gross profit margin = (Gross profit / Revenue) x 100

Using the bakery example above: ($12,500 / $25,000) x 100 = 50% gross profit margin. That means for every $1 in sales, $0.50 goes toward covering direct costs and $0.50 is left over.

The percentage is especially useful when you want to measure profitability over time, compare yourself against industry averages, or benchmark against competitors. A dollar figure alone doesn't give you that context because revenue levels can vary widely.

Gross profit vs. net profit

Gross profit only accounts for the direct costs of production. Net profit goes further by subtracting all remaining business expenses, including operating costs, interest, and taxes.

Net profit = Gross profit - Operating expenses - Interest - Taxes

Gross profit tells you whether your products or services are priced well relative to their direct costs. Net profit tells you whether your business as a whole is profitable after every expense is accounted for.

Here's when each metric is most useful:

• Use gross profit to evaluate pricing, supplier costs, and production efficiency.
• Use net profit to assess overall business health and whether your revenue covers all costs.

A business can have a strong gross profit but a weak net profit if overhead costs are too high. Tracking both gives you a complete picture of where your money is going.

What is a good gross profit margin?

There's no single number that counts as a "good" gross profit margin because it depends heavily on your industry and business model. Here are some general benchmarks to give you a starting point:

• Retail businesses: 25%–50%, depending on the product category
• Restaurants and food service: 25%–35%
• Professional services and consulting: 50%–70%
• Manufacturing: 25%–35%
• Software and technology: 60%–80%

A higher margin generally means you're keeping more revenue after direct costs, which gives you more room to invest in growth or absorb unexpected expenses. A lower margin might signal that your costs are too high or your pricing needs adjusting.

The most useful comparison is against your own historical data. If your margin has been steady at 45% and suddenly drops to 35%, that's worth investigating, even if 35% is considered healthy in your industry.

What affects gross profit?

Several factors can push your gross profit up or pull it down. Understanding them helps you stay ahead of problems and take advantage of opportunities.

• Revenue changes: a drop in sales volume or a shift toward lower-priced products reduces gross profit, even if your costs stay the same.
• Raw material and supplier costs: price increases from suppliers directly eat into your margins. Seasonal fluctuations and supply chain disruptions can cause unexpected spikes.
• Labor costs: wages, overtime, and contractor fees for staff directly involved in production or service delivery are part of COGS. Hiring, turnover, and training costs can also push this number up.
• Production efficiency: waste, rework, and slow processes increase costs without adding revenue. Streamlining operations can have a noticeable impact on gross profit.
• Product or service mix: if you sell multiple products, the mix matters. Shifting sales toward higher-margin items boosts overall gross profit, while a shift toward lower-margin items does the opposite.

How to improve your gross profit

Improving gross profit doesn't always mean raising prices. Here are some practical strategies you can act on.

• Negotiate with suppliers: review your supplier contracts regularly and compare quotes. Even small reductions in material costs add up over time, especially for high-volume items.
• Revisit your pricing: if your costs have gone up but your prices haven't, your margins are shrinking. Run the numbers to see where a modest price increase would have the least impact on sales volume.
• Reduce waste and inefficiency: track where materials, time, or labor are being lost in your production process. Fixing bottlenecks and reducing waste directly lowers COGS.
• Monitor profit by product or service: not everything you sell earns the same margin. Identify your highest-margin and lowest-margin offerings, then focus your marketing and sales efforts on what's most profitable.
• Automate where you can: manual processes like data entry, invoicing, and reconciliation take time and introduce errors. Using accounting software to handle routine tasks frees up time and reduces costly mistakes.

Track your gross profit with Xero

Knowing your gross profit is only useful if you're tracking it consistently. Xero makes that easy by pulling your financial data into one place, so you can generate profit and loss reports, review COGS, and spot trends without digging through spreadsheets.

With automated bank feeds and daily reconciliation, your numbers stay up to date. Xero's customizable reporting lets you break down gross profit by product, time period, or category, giving you the detail you need to make smart decisions. Get one month free.

FAQs on gross profit

Here are some frequently asked questions about gross profit.

Can gross profit be negative?

Yes, gross profit can be negative if your cost of goods sold exceeds your revenue. This sometimes happens during a business launch when startup production costs are high, or during a period of heavy discounting. A negative gross profit that persists beyond a short transitional period is a signal to reevaluate your pricing or cost structure.

Does gross profit apply to service businesses?

It does. For service businesses, COGS typically includes the direct labor and expenses tied to delivering the service, such as consultant wages, project-specific software, or travel costs. The formula works the same way; the inputs are just different from a product-based business.

What's the difference between gross profit and gross income?

In most small business contexts, the 2 terms are used interchangeably. Both refer to revenue minus COGS. Some industries or accounting standards draw a finer distinction, but for day-to-day financial tracking, they mean the same thing.

How often should you track gross profit?

Monthly tracking is a good baseline for most small businesses. It gives you enough data points to spot trends, catch issues early, and adjust before small problems become bigger ones. If your business has seasonal patterns, comparing the same month year-over-year can be more revealing than month-to-month changes.