Gross profit is used to determine how efficient a company is able to manage its resources in the creation of its products. Gross profit is also known as gross margin. Gross profit can be determined on an item-by-item basis or for a company as a whole.
Gross profit is equal to the revenues generated minus the cost of the goods that were sold. For example, if a company sold £6 million worth of furniture and it cost £5 million to produce the furniture, the gross profit would be £1.3 million.
Revenues represent all income received for goods sold and services performed by the company. These include the physical items, as well as intangible services such as warranties on the products.
Cost of Goods Sold
The cost of goods sold is calculated by adding all the costs of production. This includes the cost of the natural resources, factories and human labour to produce the goods.
Why COGs is Significant
The cost of goods sold is helpful to companies to help determine where they are spending most of their money in terms of production.
Gross profit as a measure of efficiency is limited to comparisons within a given industry. Different industries have different input requirements to calculate the costs of goods sold. For example, gross profit could be used to compare two computer companies, but it would be much less effective if you tried to use it compare the efficiency of a computer company with a logging company.