Gross profit is the basic figure as far as business of the company is concerned because in a way it is the first step towards company preparing final accounts. Gross profit refers to that profit which company earn after deducting the cost of goods sold from net sales done by the company. Let’s look at gross profit calculation in detail –
Gross profit formula is Net sales – Cost of goods sold, where net sales is calculated by deducting sales return and discounts given to customers from total sales and cost of goods sold is calculated as opening stock of goods + purchase of raw materials during the period + direct expenses related to manufacturing – closing stock of raw materials.
It can be better understood with the help of an example suppose the gross sales done by the company is $50000 out of which sales return are $5000 and discounts are $1000 then Net sales of the company will be $44000. Now the opening stock of raw materials is $20000, total purchase of raw material during the period is $30000, closing stock of raw materials is $15000 and total direct expenses like direct labor, wages and expenses and so on are $5000 then cost of goods sold is equal to $40000 which is calculated as follows – $20000 + $30000 + $5000 – $15000. Now net sales are $44000 and cost of goods sold is $40000 then gross profit of the company will be $4000.
In the above equation if any two things are given then one can calculate the third thing easily so in the above example if gross profit is given as $4000 and net sales is given as $44000 than cost of goods sold can be calculated by subtracting gross profit from net sales and it will work out to be $40000.