Gross profit

Gross profit is a very simple measure of profit. It is:

sales - cost of sales

Given that it excludes many costs, including all overheads and all financing costs, it is not a good measure of how profitable a company is as a whole, but rather of how much of a mark up it can make on sales.

Gross profit margin

When analysing a company, gross profit margin is usually more useful than absolute gross profit. How it compares to what one would expect given its industry product range is particularly important.

A company may have a high (or low) gross profit for many reasons, for example:

  1. Because it is able to charge a higher price for its products (it has managed to differentiate its products).
  2. It has a lower cost of goods sold (it is more efficient).
  3. Its accounting practices move costs from cost of goods sold to overheads or vice-versa.
  4. It is vertically integrated.
  5. Its pricing reflects the terms on which it deals with its customers (for example, selling on credit).

Changes and trends in gross profit margin often give investors useful information.

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