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Want to know if your business is actually making money or just covering costs?
That’s where the gross profit formula comes in! It helps you see how efficiently your business turns revenue into profit after accounting for production costs, providing insights into your business's financial health.
In this guide, we’ll break down what the gross profit formula is, how to calculate it, and why it matters. Plus, we’ll share some practical tips to boost your gross profit margin and keep your business financially strong.
Let’s get into it!
What Is the Gross Profit Formula?
Ever looked at your sales figures and thought, “Great, I made money! But how much of it do I actually keep?”
That’s where the gross profit formula comes in! It helps you see what’s left after covering the direct costs of producing your goods or services.
Gross Profit = Total Revenue – Cost of Goods Sold (COGS)
Total Revenue – The total income from sales before anything gets deducted.
COGS (Cost of Goods Sold) – The direct costs of making your product or delivering your service. This includes materials, direct labour, and manufacturing costs.
Understanding this formula is key for tracking profitability, making smarter pricing decisions, and improving efficiency.
And if you want to make tax and profit tracking easy, the Pie Tax app helps you manage everything in one place, so you always know where your business stands!
How to Calculate Gross Profit (Step-by-Step Guide)
Don't worry! We've got you. Calculating gross profit is easy once you break it down:
Step 1: Identify Your Revenue
This is your net sales before taking out expenses.
Step 2: Work Out Your Cost of Goods Sold
Add up all direct costs: raw materials, labour, and anything else needed to produce your product or service. COGS includes variable costs such as raw materials and labour, which change with production output.
Step 3: Apply the Formula
Simply perform a gross profit calculation by subtracting your COGS from total revenue, and there’s your gross profit!
For example, let’s say your business earns £100,000 in revenue, and your COGS is £40,000:
👉 £100,000 – £40,000 = £60,000 Gross Profit
The higher your total gross profit, the better your business efficiency, but there’s more to it than just a number!
Why Gross Profit Matters
Gross profit isn’t just a number, it’s a key indicator of how well your business is running. If it’s high, you’re keeping production costs low and maximising earnings. If it’s shrinking, something’s eating into your profits, and that’s a red flag.
It also affects pricing strategy. If your margins are too tight, it might be time to adjust prices or cut costs. Getting this right ensures your business stays profitable without compromising quality.
And let’s not forget net profit. A healthy gross profit means you can cover operating costs like rent and salaries while still making money.
If yours isn’t where it should be, it’s time to rethink expenses, pricing, or operations. Small tweaks can lead to big financial improvements!
Gross Profit vs. Net Income – What’s the Difference?
Ever looked at your business numbers and thought, "Wait, why is my net income so much lower than my gross profit?" You’re not alone!
These two metrics measure different things, and understanding them can help you make better financial decisions.
Gross profit is what’s left after subtracting the cost of goods sold (COGS): things like materials and direct labour. It tells you how efficiently you’re producing and selling your products. But it doesn’t factor in rent, salaries, marketing, or taxes.
That’s where net income (also called net profit) comes in. It’s the real bottom line, the amount left after every single expense is deducted. If gross profit looks great but net income is struggling, you might be spending too much on overheads or not charging enough.
Both numbers matter. Gross profit helps with pricing and production decisions, while net income shows how profitable your business really is. Knowing the difference means smarter choices, better margins, and more money in your pocket!
Common Mistakes When Using the Gross Profit Formula
At Pie Tax, we see many business owners make small mistakes that add up over time. Here are some to avoid:
Forgetting Hidden Costs – COGS includes more than just materials, don’t forget labour, storage, and production costs!
Confusing Gross and Net Profit – Gross profit only covers direct costs, while net profit includes everything: operating expenses, taxes, and overheads.
Ignoring Industry Benchmarks – If your gross profit margin is lower than competitors, you might be underpricing or overspending on production.
Not Excluding Fixed Costs – Fixed costs, such as salaries, marketing expenses, and rent, are not included in the gross profit calculation. Focus on variable costs that fluctuate with production output.
Keeping track of gross profit properly helps you make better financial decisions and stay competitive.
And with our Pie Tax app, you can easily monitor income, expenses, and profit margins, so you’re always in control!
How to Improve Your Gross Profit Margin
If your gross profit margin isn’t where you want it to be, don’t panic! Improving gross profit margin involves strategies to increase gross profits. There are a few simple ways to boost it:
Lower Production Costs – Negotiate better supplier deals, reduce waste, or optimise labour costs.
Increase Prices (Carefully!) – Raising prices too much can drive customers away, but a small increase might be enough to improve margins.
Boost Sales Without Raising Costs – Focus on higher-margin products or upsell to existing customers to increase revenue without extra expenses.
At the end of the day, gross profit is a balance. Cutting costs without sacrificing quality and increasing sales without raising expenses too much. By keeping an eye on your gross profit margin, you’ll make smarter financial decisions and keep more of your hard-earned money! Win win.
For more guidance on managing business profits and expenses, check out the official HMRC guide on self-employed income and tax!
Final Thoughts
Understanding gross profit vs. net income isn’t just about crunching numbers! It’s about making smarter business decisions.
Gross profit shows how efficiently you’re producing goods, while net income tells you what’s actually left after all expenses. If your net income isn’t where you want it to be, it might be time to adjust pricing, cut unnecessary costs, or improve efficiency.
The good news? Pie Tax makes tracking profits and expenses effortless! With our free tax app, you can monitor your income, keep on top of business costs, and make sure you’re always in control of your finances, without the headache.
Happy taxing!
