Not knowing the difference between your gross profit and your gross receipts will not only leave you in a bit of a pickle when you have to do your year-end accounts, it’s also likely to mean that you don't have a firm understanding of your company's profitability. Familiarizing yourself with the meaning of these terms will shed a great deal of light on the health of your business.
Gross profit is the amount of money a business makes on a sale. You can calculate the gross profit that your company makes on an individual sale by subtracting the sale price of an item from its cost price. So, if you bought an item to sell in your store for $5 and sold it for $8, your gross profit would be $3. Your gross profit for an accounting period is the sum total of the gross profit made on all your sales. Gross profit is not a good barometer of a company's profitability, as it doesn't factor in overheads such as staffing, tax, rent and other costs.
Gross receipts are the total of all the payments made to your company in an accounting period, without any deductions. To calculate your company's gross receipts, add together every payment that came into your firm over an accounting period, including rental or interest income. Do not deduct any costs, including returned items.
You can calculate your net profit by subtracting all of your company's payments from your gross receipts. Include all operating costs, debt payments and your firm's tax liability for the accounting period.
Although your company's gross profit doesn't tell you much about the profitability of your business, you can use it to calculate your profit margin. You can then use this to compare your mark-up to your industry's average to make sure you're pricing competitively, or establish whether you need to look at your supply chain. Divide your gross profit on a sale by its cost, and then multiply the figure you're left with by 100 to get your profit margin. So, if you've made a gross profit of $3 on a sale that cost your $5, divide three by five and multiply the result, 0.6, by 100. This leaves you with a healthy 60% mark-up.
Michael Roennevig has been a journalist since 2003. He has written on politics, the arts, travel and society for publications such as "The Big Issue" and "Which?" Roennevig holds a Bachelor of Arts in journalism from the Surrey Institute and a postgraduate diploma from the National Council for the Training of Journalists at City College, Brighton.