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:
- Because it is able to charge a higher price for its products (it has managed to differentiate its products).
- It has a lower cost of goods sold (it is more efficient).
- Its accounting practices move costs from cost of goods sold to overheads or vice-versa.
- It is vertically integrated.
- 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.