In accounting, numerous terms are involved, each with its own unique importance. When talking about profitability, we usually refer to net profit frequently. However, there is another type of profit that is just as important in the same context, and that is "gross profit". You have probably come across gross profit when looking at the accounts of any business. But do you know what it is and how it can be distinguished from net profit? Let's understand the meaning of Gross Profit, its importance and how to calculate it. Also, we briefly explain the meaning and importance of Gross Profit Margin. : UPI Payments in India

In accounting, numerous terms are involved, each with its own unique importance. When talking about profitability, we usually refer to net profit frequently. However, there is another type of profit that is just as important in the same context, and that is "gross profit". You have probably come across gross profit when looking at the accounts of any business. But do you know what it is and how it can be distinguished from net profit? Let's understand the meaning of Gross Profit, its importance and how to calculate it. Also, we briefly explain the meaning and importance of Gross Profit Margin.

What is gross profit?

Gross profit, also known as gross margin, is the profit earned from the sale of goods. When calculating gross profit, you need to ignore all overheads. Here is a clear formula for gross profit:

Gross profit = total sales - total cost of goods sold

The above equation can be further expanded as:

Gross profit = (sales + closing stock) - (opening stock + purchases + direct costs)

When preparing the final accounts, you will usually arrive at a gross profit as a balancing figure for the trading account, which is then transferred to the profit and loss account to calculate the net profit.

Gross profit shows the profit a business makes from selling goods before adjusting for overheads. Overheads usually include overheads, selling and distribution expenses, etc.

What is cost of goods sold?

Cost of goods sold usually includes all the costs involved in selling goods. For example, purchases, direct wages, direct materials, and manufacturing costs are all part of cost of goods sold. These costs usually vary depending on the amount of merchandise sold. The more merchandise sold, the higher the cost of goods sold.

Gross Profit Margin (GPM)

While gross profit is an absolute value, expressing it in relative terms (percentages) is necessary to draw meaningful conclusions. Gross Profit Margin (GPM) measures the profit a business earns on its sales. Below is the formula for Gross Profit Margin:

Gross Profit Margin = (Gross Profit / Net Income)* 100

Among them.

Net Income = Total Sales - Returns.

The gross profit margin formula above shows the ratio of gross profit to net sales. The higher the gross profit margin, the more profit the firm makes from its goods.

Importance of gross profit and gross profit margin

Whilst you may already have a clear idea of what gross profit and gross margin mean, it is vital to understand their role and importance. Gross profit shows the amount of money available to cover the overheads of the business.

This usually includes fixed costs such as rent, wages, electricity, maintenance, repairs, interest, etc. These costs are not incurred directly as a result of sales, but are necessary to run the business.

You need to ensure that you are making enough gross profit to cover overheads and earn a net profit. The gross profit margin serves as a benchmark that shows whether you are making enough profit.

Whilst the amount of gross profit may vary depending on the increase or decrease in the turnover of the business, you should endeavour to maintain a gross profit margin ratio. Gross profit margin is therefore an important profitability ratio that financial experts use to determine the profitability of a business.

Practical examples to determine gross profit and gross profit margins

Suppose Mr A runs a trading business. Here are the figures he presents at the end of the financial year:

Opening stock: Rs 1,40,000

Purchase amount: Rs. 4,95,000

Sales: Rs. 7,46,000

Closing stock: Rs. 1,72,000

Direct salary: Rs 95,000

Therefore, by applying the gross profit formula and the profit margin formula:

Gross profit = (7,46,000 + 1,72,000) - (1,40,000 + 4,95,000 + 95,000) = Rs 1,88,000

Gross Profit Margin = Rs. 1,88,000 / Rs. 7,46,000 = 25.20%

Gross profit and gross profit margin

In short, both gross profit and gross profit margin are key to determining whether a business is making enough profit to cover its operating and administrative costs. Further, you should endeavour to maintain or improve your gross profit margin to increase profitability.

However, it is also important to collect customer payments in a timely manner to increase profitability.PayU allows you to easily collect online and offline payments, enabling businesses to accept payments in a timely manner and maximise profitability.

Related reading: 7 Quick Steps to Product Pricing

common problems

How is gross profit calculated in the service sector? Gross profit can be calculated if goods are involved. Therefore, if the service industry does not include goods, gross profit cannot be calculated. If the gross profit is negative, is it possible for the net profit to be positive? Yes. In rare cases, net profit may be positive even if gross profit is negative. For example, in the case of a sale of a major asset that is worth more than its current book value, net profit may be positive even if the business reports a negative gross profit or gross loss. Secondly, if the business has a large amount of indirect income, net profit may be positive even if there is a gross loss. How can I increase the gross profit of my business? In order to increase the gross profit of your business, you can do the following: increase the selling price of your goods, reduce the purchase price, and eliminate unnecessary direct costs.