A company's sales revenue (also referred to as "net sales") is the income that it receives from the sale of goods or services. For example, if a company charges $300 for a TV and sells 1000 TVs, its sales revenue is $300,000.
On the other hand, gross profit is the income that a company makes from its sales after the cost of the goods and operating expenses have been subtracted. This includes expenses that depend on the company's sales – such as materials, labor costs, equipment, sales commissions, and depreciation that results from production -- all variable costs. It does not include fixed expenses such as rent, insurance, administrative costs, and other expenses that don't directly depend on sales.
Here are some examples of expenses that would and would not be included in calculating gross profit:
|
Included |
Not Included |
|---|---|
|
Materials used to make a product |
Office supplies and equipment |
|
Labor costs (for individuals involved in making products) |
Labor costs (for office personnel and other non-production employees) |
|
Shipping costs |
Advertising costs |
|
Packaging expenses |
Rent |
|
Depreciation on facilities and equipment used in production |
Insurance expense |
|
Machinery used in production |
Employee benefits |
To illustrate this, consider the following data from Apple's 2014 income statement:
|
Metric |
Amount ($Billions) |
|---|---|
|
Net Sales (Revenue) |
182.8 |
|
Cost of Goods Sold |
104.3 |
|
Depreciation and Amortization |
8.0 |
|
General and Administrative Expenses |
18.0 |
|
Research & Development |
6.0 |
Using the above data, in order to calculate the gross profit we need to subtract the cost of goods sold as well as the depreciation and amortization expenses.
By calculating a company's gross profit, you can use the information to calculate the gross profit margin, which is equal to the gross profit divided by the revenue. This is a good way to determine how efficiently a company is producing its products compared to the rest of its industry, and to its own historical performance.
So, in the case of our Apple example, the gross profit margin would be equal to $70.5 billion divided by $182.8 billion, or 38.6%.
Be careful not to confuse gross profit with operating profit, which is a better indicator of the overall profitability of a company. In addition to accounting for the cost of goods, operating profit subtracts the company's operating expenses and expenses associated with developing new products. When evaluating the profitability of a business, bear in mind that it is entirely possible for a company to produce strong gross profits, but to still operate at a loss because of high fixed expenses.
