Gross profit formula: how to calculate gross margin

The gross profit formula is net sales minus cost of goods sold. It tells you how much money your products earn before rent, booth fees, wages and everything else that keeps the doors open. For a small shop, market stall or food truck, it’s the clearest single measure of whether your prices and costs make sense.

This guide covers how to calculate gross profit and gross margin, a worked example, how gross margin differs from net margin, and practical ways to raise gross profit without selling more.

What gross profit means

Gross profit is what’s left of your sales after paying for the goods you sold. If you sell a candle for $24 that cost you $9, the gross profit on that candle is $15. Add that up across every sale in a month and you have the month’s gross profit.

It isn’t the money you get to keep. Gross profit still has to cover your operating expenses. What’s left after those is operating profit, and after interest and taxes it becomes net income. Our guide to revenue vs profit lays out the whole chain.

The gross profit formula

Gross profit = net sales − cost of goods sold

• Net sales is gross sales minus discounts, returns and refunds. Sales tax you collected isn’t part of it, since that money belongs to the state.
• Cost of goods sold is what the products you sold cost you: beginning inventory plus purchases minus ending inventory. Our guide to the cost of goods sold formula walks through it.

The gross margin formula

Gross profit in dollars is useful, but it’s hard to compare a $10,000 month with a $40,000 month. Gross margin turns it into a percentage of sales:

Gross margin % = gross profit ÷ net sales × 100

A 56% gross margin means 56 cents of every sales dollar is left after paying for the product. The other 44 cents went to the goods themselves.

A worked gross profit example

Take a small clothing boutique in October:

Gross margin is $14,840 ÷ $26,500 = 0.56, or 56%. For every $100 of clothing the boutique sold in October, $56 was left to pay rent, wages, card fees and the owner.

Gross profit per product

The same formula works on a single item:

The scarf has the lowest margin but earns the most dollars per sale. Both views matter: margin tells you how efficient a product is, dollars tell you what it contributes. You can check any item in seconds with the profit margin calculator.

Gross margin vs markup

These get mixed up constantly. Margin is profit as a share of the price. Markup is profit as a share of the cost. The candle above has a $15 profit on a $9 cost, so its markup is $15 ÷ $9, about 166.7%, while its margin is 62.5%. Same candle, same profit, two very different-looking numbers. When a supplier or another seller quotes a percentage, ask which one they mean.

Gross margin vs net margin

Gross margin only subtracts the cost of the goods. Net margin subtracts everything: the goods, rent, wages, booth fees, card fees, insurance, interest and taxes. Back to the boutique:

The two numbers answer different questions. Gross margin asks whether your products are priced well against what they cost. Net margin asks whether the whole business is profitable. A shop can have a healthy gross margin and still lose money if rent or wages are too high. For the broader difference between gross and net, in sales and in pay, see our guide to gross vs net.

What’s a good gross margin?

It depends on what you sell. Resellers of branded goods often run thinner margins than makers selling their own work. Food businesses usually think in reverse, tracking food and paper cost as a percentage of sales instead of gross margin. A good margin is one that leaves enough to cover your operating expenses with something left over.

The more useful question is whether your margin is steady. Track it month to month. A sudden drop usually points to one of a short list of causes: a supplier price increase you didn’t pass on, heavier discounting, more shrinkage, or a shift in your sales mix toward lower-margin items.

How to raise gross profit

There are only two levers: earn more per sale, or spend less on what you sell.

• Raise prices on your best sellers. Raising the candle from $24 to $26 lifts its gross profit from $15 to $17, and its margin from 62.5% to about 65.4%. Customers rarely notice a small increase on an item they already love.
• Update prices when costs rise. If a supplier raises a cost by 8% and your price stays put, your margin shrinks every sale. Review cost prices whenever new invoices come in.
• Watch discounts. A 20% off sale on a 50% margin item gives away 40% of its gross profit. The discount calculator shows what a markdown does to the final price.
• Buy better. Larger orders, fewer rush shipments and comparing suppliers can trim cost per unit. Freight counts, so consolidating orders helps.
• Cut waste and shrinkage. Spoiled food, broken stock and theft all inflate cost of goods sold. Regular counts catch it early.
• Push higher-margin items. Put them at eye level, suggest them as add-ons, feature them at the front of the booth. Our guide to contribution margin shows how to rank products by what each sale actually brings in.
• Drop or reprice the laggards. An item that takes up shelf space and earns very little gross profit is costing you room for something better.

How often to check gross profit

Monthly is a good rhythm for most small sellers. It lines up with supplier invoices and bank statements, and a month is long enough to smooth out a slow Tuesday or a rained-out market. Seasonal businesses should also compare each month with the same month last year, since a December gift shop and a February gift shop are not the same business.

Product-level margins are worth a look more often, especially after a supplier price change or before a sale. If you only count stock once a year, you can still estimate monthly gross profit from your sales and your product cost prices, then correct it against the real count at year end. The gap between the two tells you how much shrinkage, breakage and waste cost you.

Common gross profit mistakes

• Using gross sales instead of net sales. Forgetting discounts and refunds makes your margin look better than it is.
• Including sales tax in sales. Tax you collect isn’t revenue and shouldn’t sit in the top line.
• Using purchases instead of COGS. Only the cost of what sold belongs in the formula, not everything you bought that month.
• Putting operating expenses in COGS. Booth fees and card fees go below gross profit, not above it. Mixing them in makes months hard to compare.

Where SleepingFire fits

SleepingFire is point-of-sale and inventory software, not accounting software, so it doesn’t produce a P&L or a gross profit line for the business. It does give you the inputs and a product-level view. Sales reports for any date range show your sales, discounts and refunds, the profit margin report shows margin for each product based on its price and cost, and the inventory valuation report gives your stock at cost for working out cost of goods sold. See the sales reports.

Frequently asked questions