Gross profit explained in simple terms

For a freelancer and entrepreneur, profit is a central unit of measurement that determines the success or failure of a business. Profit is broken down into gross and net profit. In this post, we take a closer look at gross profit and give you an example of how to calculate it for your SME.

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What is gross profit?

Gross profit is calculated from your revenue minus purchase or production costs. Gross profit is so called because, in the calculation, only variable costs are deducted and no fixed costs such as employee salaries, rental costs for business premises, electricity, etc.

How is gross profit calculated?

Your gross profit is calculated from the quantity of products sold minus the production or purchase costs. This means that only variable costs and no fixed costs are taken into account in the calculation. VAT, which varies between 8.1% and 2.6% depending on the type of product, is also still included in the calculation of gross profit.

The formula for the calculation is as follows:

Gross profit = Revenue* – Purchase value

(*Revenue = Sales quantity x Selling price)

For your business to be successful, you need revenue. This means that you should sell the goods or services you offer to enough customers to cover your costs. The 'revenue' variable tells you how much money you have made in a given economic period. If you then deduct costs from this revenue, you get your company's profit, which, in turn, is broken down into gross and net profit.

Gross profit corresponds to the profit before EBITDA (earnings before interest and taxes, depreciation and amortisation). If you then subtract any depreciation and amortisation from the calculated EBITDA, you get the EBIT (earnings before interest and taxes). This gives you two key figures that form part of the income statement and, thus, also the full annual financial statements.

It is important that you as an entrepreneur do not rely solely on these key figures to make commercial conclusions, as no costs have yet been taken into account in the calculation. If your gross profit is less than your costs, your company will make a loss. The variables are good for guidance and for finding out how your company is doing in terms of earning power, but not as a clear indicator.

How gross profit is calculated – an example

Let's use an example to explain gross profit more clearly. Mr P runs a bike business and specialises in e-bikes. He buys the Highlander mountain bike model from a wholesaler for CHF 1,200. He buys 10 of them and offers them to his customers at a selling price of CHF 1,700 each, including VAT.

His revenue per bike sold is calculated as follows:

1 x CHF 1,700 = CHF 1,700

This results in the following calculation for the gross profit on a bike:

CHF 1,700 – CHF 1,200 = CHF 500

Mr P sells a total of five of these e-bikes in the 2021 season. He now has five more models in stock.

Revenue from five bikes sold:

5 x CHF 1,700 = CHF 8,500

Purchase costs for 10 bikes:

10 x CHF 1,200 = CHF 12,000

Gross profit = CHF 8,500 – CHF 12,000 = – CHF 3,500

Since Mr P bought more goods than he sold this season, a negative gross profit is calculated. From this, he can abstract the following possible actions for the next financial year:

  • Calculate the purchase of goods better
  • Increase the selling price per bike
  • Increase promotional efforts to drive sales
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What is the gross profit margin?

The gross profit margin corresponds to the difference between the selling price and the purchase or production costs. The term 'margin' comes from French and signifies 'span' or 'leeway'. Companies use the calculated margin to cover costs and generate profit.

In our example above, Mr P's gross profit margin is calculated as follows:

Gross profit margin = Selling price – Purchase price = CHF 1,700– CHF 1,200= CHF 500.-

Why is setting the right margin so important?

Effect

Reason

Margin too high

High risk of not being competitive

Competitors offer products at lower prices but with the same quality

Margin too low

Not enough revenue is generated to sufficiently cover costs

Product prices are too low, and the company may make a loss

Gross profit with bexio

As an entrepreneur, you know that accounting is a must. All the better if you can do this often tiresome task with an accounting software like bexio.

Accounting also includes the income statement, also referred to as the profit and loss account. The calculation of profit is a key indicator to find out how commercially successful your company is. A simplified example of an income statement:

Third level income statement example en

A distinction must be made between the single-step income statement and the multi-step income statement. In the bexio business software, your income statement is presented in 5 steps.

As the name suggests, the company's profit is calculated in the multi-step income statement using a corresponding multi-step process. When you manage your accounting in bexio, the software does almost all of this for you. In your account, you can view your income statement and use the most important key figures to see how economically stable your company is.

FAQ: Frequently asked questions about gross profit

What is net profit?

Net profit is a company's profit after all expenses have been deducted from the revenue for a specified period. You thus deduct all operating costs (including taxes, depreciation and amortisation, etc.) from your gross profit and get the net profit. The result is the profit that the entrepreneur can use to further expand the business.

Gross profit in the income statement

Gross profit is included in every complete income statement for a company. It is the figure that is calculated on the basis of revenue and provides information on how much a company has earned from simply selling its goods or services in a given period.

What are gross proceeds?

Gross proceeds correspond to revenue in a given period. They represent the sum of the selling price multiplied by the quantity. No costs are taken into account in the result of the gross proceeds.

Is it mandatory for companies to calculate gross profit?

Depending on their legal form, companies are legally obliged to keep accounts. The gross profit forms part of the income statement and balance sheet, which form part of the annual financial statements. However, it is worth calculating the gross profit in any case in order to determine your gross profit margin and thus determine your pricing policy.

What is the significance of gross profit for a company?

The value of the gross profit indicates how much a company has earned in a certain period from selling products and can thus give an indication of the company's stability. However, the gross profit does not yet take into account all costs and expenses and should therefore be used with caution as a management tool.

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