Gross profit is net sales less cost of goods sold. In a common multiple-step income statement, it is the first subtotal. It shows how much of net sales remains after the recognized cost of the goods sold.
A retailer with $900,000 of net sales and $585,000 of cost of goods sold reports $315,000 of gross profit. The gross profit rate is 35 percent:
gross profit rate = $315,000 / $900,000
The rate can make different-sized periods easier to compare. It can also be rearranged: given a supported rate and either net sales or gross profit, the third figure follows. That relationship is part of the gross profit method of estimating inventory. An estimate still requires a supported rate and a defined inventory population.
The line above the subtotal contains cost of goods sold, not every cost of running the business. Freight incurred to acquire inventory can enter product cost. Delivery to the customer is usually a selling cost after control transfers. Sales salaries also sit below gross profit in the common teaching format. A wrong classification changes the subtotal without changing net income, which is why every account needs a controlled mapping.
A falling rate is a signal rather than a conclusion. Price changes, product mix, input costs, shrinkage, cutoff, and classification can all move it. Compare entities only after checking their revenue, inventory-cost, period, and policy boundaries.
Build the subtotal in the multiple-step lesson. The Granite Harbor reconciliation checks the amount, rate, and effect of a reclassification. Then complete the formative subtotal task.
Put the concept to work
Understand this concept
- Explain what gross profit measures, which items sit above it, and why a cost that varies with volume belongs above the line and a period cost does not.
Apply this concept
- Compute gross profit and the gross profit rate from net sales and cost of goods sold, and use the rate to solve for whichever of the three is unknown.
Learning resources
Choose a lesson, try an application, or inspect the sources behind this concept.
Build on these ideas
- Cost of goods sold — Analyze
To apply this concept: Helpful. Reading the rate depends on what moved cost of goods sold.
- Cost of goods sold — Understand
To understand this concept: Required. Gross profit is defined by the cost subtracted to reach it.
- Gross profit — Understand
To apply this concept: Required. Computing the subtotal requires knowing what belongs in it.
Show 1 more prerequisites
- Revenue — Understand
To understand this concept: Required. The subtotal starts from net sales.
Lessons
Worked examples and cases
Practice
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Common mistaken ideas
Sources
Related concepts
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Use this idea next
- Gross profit — Apply
Required level here: understand. Required. Computing the subtotal requires knowing what belongs in it.
- Multiple-step income statement — Understand
Required level here: understand. Required. Gross profit is the first subtotal the format adds.
- Operating income — Apply
Required level here: apply. Required. The subtotal is built on top of gross profit.
Show 1 more next steps
- Operating income — Understand
Required level here: understand. Required. Operating income is the next subtotal down from gross profit.
Used in these readings
These chapters explain or apply this concept. The label states how the chapter uses it.