Gross profit is the amount of income left over after the company pays for product costs. Gross profit indicates how much money is left to pay other company expenses, such as selling and administrative costs. The gross profit margin percentage represents gross profit in a percentage format. Gross profit is equal to net sales less cost of goods sold. Gross profit margin percentage is gross profit divided by net sales.
Identify net sales revenue for the period. Net sales revenue is sales revenue from all products and services less any allowance for sales returns. For example, say a company had sales revenue from two products that totals $400,000 and expects product returns to be 1 percent of product sales. The allowance for sales returns is $4,000 and the net sales revenue for the period is $396,000.
Identify cost of goods sold for the period. Cost of goods sold is the cost the company paid to produce the products it sold that period. Calculate cost of goods sold by adding all direct labor, direct materials and factory overhead for the products sold. To calculate direct labor, add the wages, bonuses, benefits and payroll taxes for all individuals involved in creating the product. Direct materials is all raw materials, supplies and components purchased and used to create or modify the product. Factory overhead is costs incurred to create the product that don't fall in the other two categories, like supervisor salaries, rent, utilities, factory supplies and equipment.
Subtract cost of goods sold from net sales revenue to determine the gross profit for the period. For example, if net sales is $396,000 and cost of goods sold is $96,000, the gross profit is $300,000. This means that, out of the $396,000 earned for the period, $300,000 is the amount of profit before considering selling and administrative expenses. If a company sells products at a loss, gross profit will be negative. For example, a company with net sales of $200,000 and cost of goods sold of $300,000 has a gross profit of minus-$100,000, or, termed differently, a gross loss of $100,000.
Divide gross profit by net sales to calculate the gross profit margin percentage. For example, for a company with a gross profit of $300,000 and net sales of $396,000, you divide $300,000 by $396,000 to arrive at a gross profit margin of 76 percent. This means that for each dollar of product sold, 76 cents is gross profit and 24 cents is product cost.