Concepts

Gross profit

Gross profit is your sales minus the direct cost of the goods or services sold, showing how much is left to cover overheads and produce a net profit.

Gross profit is calculated by taking your sales revenue and subtracting the cost of sales. It shows how much each dollar of sales contributes after the direct costs of what you sold have been met. It does not take into account overheads such as rent, wages for office staff, marketing and utilities. Those come off later to arrive at net profit. Gross profit is therefore a measure of basic trading performance.

It is often expressed as a percentage, called the gross margin. If your gross profit is $40,000 on sales of $100,000, your gross margin is 40%. Watching this percentage helps you see whether your pricing and your supplier costs are sustainable. A falling margin can signal rising costs, discounting, waste or errors in recording stock, and it prompts you to investigate before the problem flows through to net profit.

For GST-registered businesses, it is important to calculate gross profit using GST-exclusive amounts. Sales figures that include GST would overstate your income, because the 10% GST belongs to the ATO, not to you. Similarly, the cost of sales should be recorded excluding GST that you can claim back. Mixing GST-inclusive and GST-exclusive figures is one of the most common reasons why margins in a small business look wrong.

Gross profit is useful for planning pricing. If you know your overheads and your target net profit, you can work out the gross profit you need and set prices accordingly. It also helps when assessing individual products, jobs or customers. A line with a high turnover but low gross profit may use more time and cash than it deserves, while a lower-volume line with strong margins may be more valuable.

For tax purposes, gross profit is not itself a line item on a return in the same way that it is in management accounts, but the components are. Sales are part of assessable income, and the cost of trading stock is a deduction. Financial statements prepared for lenders or for a tax agent typically show gross profit, because it summarises the trading side of the business before general expenses are deducted.

A common misunderstanding is confusing gross profit with net profit, or believing that a good gross profit means the business is profitable. High overheads can still produce a loss. Another is applying the margin to GST-inclusive prices. If a business marks up cost by 50% the selling price before GST is cost times 1.5, and GST is then added. This is general information only, so confirm how this applies to you with the ATO or a registered tax professional.

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