When it comes to running a business, one of the most important financial metrics you need to understand is gross profit and gross profit percentage. These figures are fundamental to assessing the health of your business, setting pricing strategies, and making informed financial decisions.
But what exactly do we mean by gross profit and gross profit percentage? How do they impact your business? And how can you use these insights to drive profitability? Let’s break it all down in a way that’s easy to understand.
Gross profit is the profit you make after subtracting the direct costs of delivering your product or service from your revenue. These direct costs are also known as cost of goods sold (COGS) or cost of sales.
For example, if you run a business that sells craft beer, your direct costs include:
If your business sells services rather than physical products, direct costs might include:
A key point to remember is that these costs only occur when you sell a product or service. If no sales happen, these costs wouldn’t exist. This differs from fixed costs, such as rent, salaries, and utilities, which must be paid regardless of sales volume.
The formula for gross profit is:
Gross Profit = Revenue - Cost of Goods Sold (COGS)
For example:
This means you have $300,000 left to cover your operating expenses, taxes, reinvestment, and ultimately, your net profit.
While gross profit tells you the total dollar amount left after covering direct costs, gross profit percentage (also called gross margin) expresses this as a percentage of revenue.
The formula for gross profit percentage is:
Gross Profit % = (Gross Profit / Revenue) × 100
Using our earlier example:
This means that for every dollar in revenue, 60 cents is left after covering direct costs. The remaining 40 cents is spent on producing the product or delivering the service.
Your gross profit percentage is a critical indicator of how efficiently your business produces and sells its goods or services. Here’s why it matters:
If your gross profit margin is too low, you may not be charging enough for your products or services. Alternatively, high direct costs might be eating into your profits.
A strong gross profit margin means your business is earning enough on each sale to cover operating expenses and grow sustainably. If margins are tight, you may struggle with cash flow and profitability.
Comparing your gross profit percentage to industry benchmarks can help assess whether your business is performing competitively. Different industries have different average margins, so it’s essential to understand where you stand.
If your gross profit percentage isn’t where you want it to be, consider these strategies:
One of the quickest ways to improve gross profit is by increasing your prices — as long as your market will support it. Before raising prices, consider:
Lowering your direct costs will directly improve your gross profit margin. Ways to do this include:
Not all products or services have the same gross margin. By focusing on selling more high-margin items, you can improve your overall gross profit percentage. This might mean promoting certain products, bundling services, or repositioning your offerings.
For product-based businesses, wasted raw materials or inefficient production processes increase COGS and reduce gross profit. Streamlining production, minimising wastage, and investing in technology can help.
Holding too much stock can lead to high storage costs, spoilage, or outdated products that need discounting. Efficient inventory management ensures you’re not tying up cash in excess inventory.
Many businesses focus on top-line revenue without considering whether their sales are actually profitable. High revenue with a poor gross margin can still lead to a failing business if costs aren’t managed effectively.
Offering heavy discounts can drive sales volume, but it shrinks gross profit margins. Before discounting, consider:
Gross profit margins fluctuate due to cost changes, pricing adjustments, and market conditions. Regular monitoring helps identify trends early and make proactive adjustments.
Understanding gross profit and gross profit percentage is essential for making smart business decisions. These figures tell you how efficiently your business operates and whether your pricing and cost structures are sustainable.
By regularly analysing your gross profit, optimising pricing, managing costs, and improving operational efficiency, you can strengthen your business and drive long-term success.
If you need help analysing your margins or setting up a plan to improve profitability, our team at RightWay is here to help. Contact us today to take control of your business finances and ensure a profitable 2025!