Ever heard the phrase ‘gross profit’ or ‘the % gross profit margin’ used and not been too sure what it all means? Here we run through the definitions of Revenue, Direct Costs and finally Gross Profit to help explain it all.
What Is Revenue? 💵
Revenue is also known as Turnover, Income, Sales or the Top Line.
This is all the sales that you made in the defined period (could be weekly, monthly, or annually, for example). It doesn’t matter whether this revenue comes from selling products, subscriptions, or services, the sales for that defined time period are recorded as revenue.
What Are Direct Costs? 💸
Direct costs are also known as Cost of Goods Sold (COGs), variable costs, and gross costs.
The costs associated with generating the revenue in the time period. These costs are often thought of as concrete but in fact they often fluctuate with revenue. For example, costs could include:
- the cost of making or buying in a product
- the cost of direct labour involved in delivering a service
- costs that will generally fluctuate with revenue, for example: payment processing
What Is Gross Profit? 📈
This is an indicator of your business’s ability (by your revenue) to cover the costs of providing your customers with your goods or services. Another way to look at this, at a unit level, is the margin between your price and direct costs.
The higher the Gross Profit Margin the more efficient the production process of the business. If a company can increase the price for goods or services without having to increase the direct costs, the gross margin will increase.
How to Work Out the Gross Profit Margin 🧮
You can work out your gross profit by using the following simple formula:
Revenue – Direct Costs = Gross Profit
So, if your revenue during 30 days is £60,000 and your costs for those same 30 days is £42,000, your gross profit will be:
£60,000 – £42,000 = £18,000
To work out the gross profit margin for that same period, you can use a financial ratio:
(Gross Profit / Revenue) x 100 = The % Gross Profit Margin
(£18,000 / £60,000) x 100 = 30%
You can find benchmark average profit margins for different sectors online and these will vary over the years and between sector. For example in 2018, women’s clothing had an average gross margin of 46.5%, whereas supermarkets and grocery stores had an average gross margin of 28.8%.
If you’d like to read more about this, check out the following articles:
- Read more about what makes up a profit and loss account.
- Read about start-up business financial projections.