The Income Statement: Gross Profit on Sales

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The Income Statement: Gross Profit on Sales

Gross profit on sales (also called gross margin) is the revenue the company earns from the sales of its products minus the cost of what it took to produce them. You can see it on the income statement:

Sample Income Statement

Let us clarify how to calculate this important number.

Sales - Cost of Goods Sold = Gross Profit on Sales

Now that was simple enough. But let us be sure we know what the terms sales and cost of goods sold mean to our friends the accountants.

Net sales

Net sales is the total revenue generated from the sale of all the company’s products or services minus an allowance for returns, rebates, etc. Sometimes on an income statement, you might see the terms gross sales, returns, rebates, or allowances. Gross sales is the total revenue generated from the company’s products or services before returns or rebates are deducted. Net sales, on the other hand, have all these expenses deducted.

Cost of goods sold

Cost of goods sold is what the company spent to make the things it sold. Cost of goods sold includes the money the company spent to buy the raw materials needed to produce its products, the money it spent on manufacturing its products, and labor costs.

Now, when you subtract all the money the company spent in the production of its goods and services (cost of goods sold) from the money made from selling them (net sales), you have calculated the gross profit on sales.

Gross profit on sales

Gross profit on sales is important because it reveals the profitability of a company’s core business. A company with a high gross profit has a lot of money left over to pump into research and development of new products, a big marketing campaign, or—better yet—to pass on to its investors. Investors should also monitor changes in gross profit percentages. These changes often indicate the causes of decreases or increases in a company’s profitability. For instance, a decrease in gross profit could be caused by an industry price war that has forced the company to sell its products at a lowered price. Poor management of costs would also lead to a decreased gross profit.