Gross profits measure the difference between the money a business makes from selling goods or services (its revenue), and the cost of producing those goods or services. Analyzing gross profit can help journalists understand how a business is competing in its industry. It can also back up—or refute—managers’ claims of good performance.
A quick measure of competitiveness
Gross profit, recorded on the company’s income statement, is sales revenue minus the cost of goods or services sold. The number is most helpful when it is converted into a percentage called gross profit margin (GPM). GPM is the gross profit divided by sales revenue, and shows how much out of every dollar of sales a company keeps in earnings. It can be compared directly to a company’s GPM in previous years, as well as to the GPM of competitors in the industry.
An important—but incomplete—story
Gross profit analysis ignores all other expenses and revenues, gains and losses. It offers a quick but incomplete analysis of a business. In general:
• If a business creates a superior brand and can charge higher prices than competitors, it should generate a higher gross profit.
• If a business is more efficient than its competitors, meaning the cost of purchasing or producing goods or services is lower than others in the market, it should generate a higher gross profit.
Overall, gross profit can tell you a lot about profit trends in an industry and whether a company is capable of competing. But it isn’t a complete story because it doesn’t consider all income statement line items, such as selling, general and administrative expenses or interest expense. It is, however, an important and easy to analyze measure of performance. (Originally reported by Steven Orpurt)