Gross profit explained simply: it is the money left from sales after you take away direct costs or cost of sales. Sales alone do not show whether your business is healthy. Instead, gross profit helps you understand pricing, costs, margins and whether each product or service gives the business enough money to cover overheads and move towards real profit. In this episode, we explain what gross profit means, how to calculate it, and why markup and margin are not the same thing.

About this episode

Profit needs to be one of the destination points on your business journey. When the journey focuses only on sales, the route can quickly become dangerous.

This episode focuses on gross profit. It explains what gross profit is, how to calculate it, how it differs from sales, and why it matters when planning prices, costs and business decisions.

We also look at markup and margin. Business owners often mix these two terms together, but they do different jobs. Markup helps you arrive at a selling price, while margin helps you understand how much profit sales generate.

Why gross profit matters

Gross profit is one of the most useful numbers in your business toolkit.

It shows the difference between what you sell and the direct costs linked to making those sales. Those direct costs may include materials, stock, production costs, direct labour or other costs that relate closely to the product or service sold.

Sales, turnover and revenue can all sound impressive. However, they do not show the full story. A business can have good sales and still struggle when gross profit is too low.

For the wider profit foundation, see What Is Profit? Gross Profit and Net Profit Explained.

What is gross profit?

Gross profit is the difference between sales and the direct costs of making those sales.

Accountants often call those direct costs cost of sales or cost of goods sold. The exact wording depends on the type of business, but the idea stays the same: what did it cost to create or provide the thing sold?

For example, an artist may sell a piece of work but also need canvases, materials and other direct supplies to create it. The difference between the selling price and those direct costs gives the gross profit.

How to calculate gross profit

The basic calculation is simple:

Sales minus direct costs equals gross profit.

In the episode, the example uses an artist selling five pieces of work for £40 each. That creates £200 of sales.

Each piece costs £20 in materials and direct costs, so five pieces cost £100 in total. The gross profit is therefore £200 of sales minus £100 of direct costs, which leaves £100 of gross profit.

That £100 is not the final profit. The business may still need to pay rent, admin, marketing, software, insurance and other running costs. After those operating costs, the next profit measure is operating profit.

For the related episode, see Explaining operating profit.

Gross profit examples by business type

Gross profit applies across many types of business, but direct costs can look different.

• Retail business: the difference between the cost of buying stock and the selling price.
• Food business: the difference between the cost of ingredients and the selling price of the meal or product.
• Training business: the difference between fees charged and direct costs such as room hire, materials, handouts or booklets.
• Manufacturing business: the difference between the selling price of products and the cost of making those products.
• Creative business: the difference between the selling price and the direct materials or production costs needed to create the work.

The key point is that gross profit is not just an accounting term. It shows whether the core activity of the business creates enough value.

Markup and margin explained

Markup and margin are related, but they are not the same.

Markup starts with cost. You take the direct cost, add a profit element, and arrive at a selling price.

Margin starts with the selling price. It looks at the profit element as a percentage of the sales price.

This difference matters because markups can be higher than 100%, but margins cannot exceed 100%. Also, margins are always lower than the equivalent markup percentage.

Markup example

Using the artist example, one piece of work costs £20 to make.

The artist adds a 100% markup, which adds another £20 to the cost. That gives a selling price of £40.

Markup works well as a simple way to set a price from cost.

Margin example

Using the same example, the selling price is £40 and the gross profit is £20.

To calculate the gross margin, divide the gross profit by the selling price. In this case, £20 divided by £40 gives a 50% gross margin.

When five pieces are sold, total sales are £200 and total gross profit is £100. The gross margin still comes to 50%.

Why gross margin is powerful

Gross margin helps you estimate how much gross profit the business should create from a given level of sales.

When you know your turnover and gross margin percentage, you can estimate the gross profit available to cover overheads and support profit planning.

As a result, margin becomes especially useful for forecasting, pricing, product decisions and deciding which products or services deserve more focus.

For a deeper look at gross profit as a business decision tool, see Why Gross Profit Matters for Business Decisions and Cash Flow.

Gross profit and VAT

The episode also highlights an important point about VAT and sales tax.

When you work out markup, margin and gross profit, make the calculations before sales taxes. If you are VAT registered, the VAT collected from customers does not belong to the business as profit. You collect it on behalf of the government.

Therefore, you should normally exclude VAT when calculating profit margins. This keeps the margin calculation focused on the business’s own sales and direct costs.

Using gross profit to make better decisions

Gross profit helps business owners ask better questions.

• Are prices high enough?
• Are direct costs rising?
• Is the product or service mix working?
• Which products generate stronger margins?
• Which services need to be reviewed?
• Is there enough gross profit to cover overheads?
• Does the business have enough margin to support growth?

These questions move the conversation beyond sales. They help you understand whether the business is building a strong enough pool of profit to support its running costs and future plans.

Gross profit, break-even and planning

Gross profit also connects closely with break-even.

Break-even shows the level of sales needed to cover costs before profit begins. Meanwhile, gross profit shows how much each sale contributes towards those costs.

Weak gross margins mean the business may need much higher sales to break even. Stronger margins mean each sale contributes more towards overheads and future profit.

For the next step in this journey, see Break-Even Point Explained: The Business Milestone Before Profit.

FAQs about gross profit explained

What is gross profit?

Gross profit is sales minus direct costs or cost of sales. It shows how much money remains after paying the costs directly linked to the products or services sold.

Is gross profit the same as sales?

No. Sales, turnover or revenue show the value of what the business has sold. Gross profit shows what remains after direct costs come out of those sales.

What is the difference between markup and margin?

Markup starts with cost and helps set a selling price. Margin starts with the selling price and shows profit as a percentage of sales.

Why is gross profit important?

Gross profit matters because it helps pay the running costs of the business. It also supports pricing, forecasting, product decisions and profit planning.

Should VAT be included in gross profit margin?

VAT should normally be excluded from margin calculations because VAT collected from customers is not business profit. The margin should focus on sales value before VAT and the direct costs linked to those sales.

Episode Timecodes

• 00:00 – Profit as a destination point in business
• 00:00 – What the episode covers: gross profit, markup and margin
• 01:57 – What gross profit means
• 02:41 – Artist example and direct costs
• 03:19 – Using the free online calculator
• 03:55 – Sales, turnover and revenue are not profit
• 04:35 – Calculating £100 gross profit from the example
• 05:07 – Gross profit examples across different business types
• 05:41 – Markup and margin introduced
• 06:14 – Markup example using cost and selling price
• 06:59 – Margin example using gross profit and sales price
• 07:38 – Why markup and margin are both used
• 08:15 – Why margin is powerful for planning and decisions
• 08:57 – Why margins cannot exceed 100%
• 09:41 – Gross profit as a powerful business metric
• 10:22 – VAT and sales tax in margin calculations
• 10:52 – Final summary and wrap-up

Related episodes

• What Is Profit? Gross Profit and Net Profit Explained
• Why Gross Profit Matters for Business Decisions and Cash Flow
• Break-Even Point Explained: The Business Milestone Before Profit

Key takeaway

Understanding gross profit gives you more than a definition. It shows how much money your core products and services create before overheads come out.

Sales are not the same as profit. Markup is not the same as margin. Once those differences are clear, pricing, planning and decision-making become much stronger.

Plan it, Do it, Profit.

“Where profit is, loss is hidden nearby.”

Further Support

The I Hate Numbers podcast helps business owners understand profit, gross margin, pricing, costs, cash flow, tax and financial performance in a practical way. We simplify business finance so you can make better decisions and feel more confident with your numbers.

If you need help understanding gross profit, improving margins, reviewing prices or planning profit more clearly, you can contact us for an initial chat.

You can also use the free online business calculators to support your profit and pricing decisions.

You can watch more practical finance and tax support on the I Hate Numbers YouTube channel, or listen and follow on Apple Podcasts.

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Where profit is, loss is hidden nearby - ancient Japanese proverb. Your business journey map needs to have profit as a destination point. If your destination is purely based on sales alone, then you need to change your route or abandon your journey completely. It will end in tears, otherwise. When you set your numbers to after profit, one of the calibration marks is gross profit. In this podcast, I want to help you understand gross profits, what it is, how you calculate it, and have a look at markup and margin and also conclude with why gross profit is such a powerful number in your business toolkit.

You're listening to the I Hate Numbers podcast with Mahmood Reza. The I hate Numbers Podcast mission is to help your business survive and thrive by you better understanding and connecting with your numbers. Number love and care is what it's about. Tune in every week. Now, here's your host, Mahmood Reza.

Hi folks. Welcome to another weekly episode on I Hate Numbers. This is the podcast with a mission to help improve your financial awareness, help you win more battles than you lose with what goes on between your ears, help you and your business make profit, save tax and save time. What's not to like? My name is Mahmood and I am the founder director of the accounting firm I Hate Numbers and also the financial storytelling platform Numbers Know How. And over the last 27 plus years, I've helped thousands of businesses with the mission of improving awareness, improving their outlook, their mindsets, and helping, importantly, their businesses make more money and have the businesses so desire.

Let's crack on with a podcast. Now in the world of numbers, gross profit doesn't mean unpleasant and it doesn't mean disgusting, though obviously making a rubbish gross profit actually is. Gross profit is this idea of like water droplets. Those water droplets that gather, that collate, they go into a fish tank of profitability is there to serve a purpose. What that purpose is, we're going to find out as we go through the podcast. First of all, what is gross profit? Well, gross profit is essentially the difference between the value of what you sell, whether it's a physical product or a service, and the immediate associated, what we call direct costs or cost of sales if you want to be more posh of making those sales.

If, for example, you are an artist, and as an artist, you're creating works of art, you're creating canvases, you're creating pictures to sell on to a client, it's likely that those works of art, you've had to spend money on materials, on canvases in order to generate those works of art. The difference between those two will be your gross profits. Hang fire folks. I'm going to introduce some numbers later on in the podcast. If you come across the term of gross profit, be aware that alternative terms can exist. And gross margin might also be a term that you come across that effectively means the same thing.

Let's get back to the calculation and let's overlay some numbers. Now, if you're sitting there listening to here, sipping your cup of coffee, hanging a glass of wine or whatever your drink of choice is, fear not about the numbers. I'm going to use some numbers always geared best for over the radio, over a broadcast, in for your own situation. Check out the show notes. I've got a wonderful free online calculator that does a lot of the heavy lifting for you and gives you amazing permutations and ways to actually look at your current pricing, your current costing, and help you work out your gross margins and gross profits.

Imagine our artist is selling works of art for £40 a time. They sell five of those works of art and that's £200 worth of sales. Excellent news, we should think. However, that level of sales at £200 is not the profit. That's purely the sales or turnover or revenue. Again, take your pick which term you prefer. Now, in order to create that cell, in order to create the work of art, our artist's friend has had to spend money on canvases, has to spend money on materials in order to create that work. Let's assume, for argument's sake, it’s cost them £20 for each work of art created.

Five lots of 20 is £100. And that means the gross profit from those cells has been £100 in total. That's the £200 worth of sales less than £100, what we call gross costs or cost of sales. And that gives you the 100 pound gross profit. Have a reference to last week, because that's not the final profit. The other profit that's going to come after we take off, perhaps the rent of the studio, the payment for admin costs, etc. will leave us with what's called operation profit. Check out the show notes for a reference to last week's podcast.

There are other examples we could include. If you are a retailer, the difference between the cost of buying your stock and selling is called gross profit. If your business happens to be a food business, a restaurant, a cafe, then the gap between the cost of making a meal, buying those items and selling them on is your gross profit. If your business is a training business, then the difference between your fees that you charge, the room higher, the materials that you generate, the handouts, the booklets, is gross profit. For a manufacturing business, the product minus the cost of making those products is the gross profit.

We've looked at the idea of what gross profit is and we've looked at how we calculate it. What I'd like to do now is to look at two terms that you are likely to come across in your business life called markup and margin. The best way to look at this is to take an illustration and let's go back to our artist example. If we look to each individual work of art, let's assume the selling price of each work of art is £40. Now, to get to that £40, our artist has looked at the cost of the materials, look to the cost of the canvases and it's come to £20.

He decides he's going to add, he's going to double it. He's going to add a mark up, what's called 100% onto that cost. Therefore the cost of 20 at £20 to represent his initial gross profit, his profit element. And that gives a price to the customer of £40. If he then sells five of those works of art, that's a total of £100 worth of cost. That's a total of £200 worth of sales. That's five lots of 40 for the selling price, and five lots of 20 is the cost. Now, markup, we said was 100%. Now, if we take that same level of profitability, so that's for each item, that's a 20 pound gross profit. The margin is where we take that profit element and we related and connected to the price that we sell the product for.

So we have a 20 pound gross profit, we have a 40 pound selling price, and using a bit of mass, is 20 divided by 40. If you tap it into your calculator, press the percentage key. If you're not, times it by 100 and that gives you a 50% margin. Again, it will work if you're doing it in total terms, £100 gross profit for selling five, £200 worth of sales for selling 5, 100 divided by 200 is a 50% gross margin. Now, the question quite naturally comes, why do we have both? Well, markup is a simple way to arrive at a selling price.

We would take the cost, we add a profit element and we arrive at the selling price. Footnote folks, if you are registered for VAT, registered for sales taxes, don't forget to add on the required amount of VAT in sales taxes. That's what you have to charge to your customer and that's what you collect on behalf of the government. Again, check out the show notes for a link to a podcast on VAT. Margin is a very powerful technique to use because if we know what level of turnover we're generating, we know what our gross margin percent is, we can work out, whatever the level of turnover is, the approximate amount of gross profit we should be creating.

And remember that gross profit is vital to our business. That provides that pool of resources, that pool of money from which we service and pay our running costs - our overheads. Markup is often used in industries where pricing might be around at that stage. It's a nice simple mechanism to use. Margin, in my opinion, in my experience, is a much more powerful thing to use for when it comes to making decisions, when it comes to forecasting, when it comes to planning, when it comes to making decisions about which products we pursue and which products we drop. A margin tends to be very widely used in the field of retailing in the world of industry, and it's much more widely used than a markup figure would be.

Having said that, markup by no way is dead, no way is buried. So it's out there. Be aware of it. To bear in mind, by the way folks, it's impossible for a margin to exceed 100%. It's mathematically impossible. Markups can be more than 100%, and margins would always be quoted lower than markups. And by margin, in this context, we're talking about the percentage. Lots of industries have different levels of margins. So a retailing business, a food business, a bar, hospitality, would tend to have a very high margin because it has high operating costs as well. Engineering industry, again, they might have high operating costs, but traditionally their margins will be much smaller.

So when you look at your margins and think is it good or bad? Have a good reference point to compare it against. And we talked about the power of gross profit. And gross profit for me is a really powerful metric. It's your ATM, it's out of the pool of resources that you generate for which you pay all your operating costs. And it's important that we maintain a healthy margin. Now, remember, folks, if you're a bit wary of the calculations, a bit wary of the numbers, then please check out the show notes for the wonderful free online calculator which will give you the answer in a matter of seconds.

And by seconds, we're talking micro seconds. Now, the whole purpose of margin earned markup, remember, the calculations are done before we consider sales taxes. If you are registered for VAT, registered for sales tax, depending on the country that you live in, remember, the price to the customer, typically, if it's a retailing space, will be including VAT. When you work out your profit margins, make sure VAT is eliminated from the calculation. So folks, let's wrap up what we have and summarise. We've talked about the idea of what gross profit actually is. It's not a disgusting figure, doesn't mean unpleasant, but obviously making a rubbish gross profit actually is.

It's important to keep an eye on gross profit. That's largely within our control, largely something we can influence. We've looked at the methodology, how we calculate that figure, we've looked to the difference between markup and margin, and we've also touched upon where gross profit serves its own is a very powerful tool in our business toolkit. I hope you enjoyed this episode and I'd love it if you could subscribe, or I'd love it if you left some feedback. Share it with your friends, share it with your colleagues, share it with those who you feel would benefit from listening to this podcast. Until next week, folks, ciao.

We hope you enjoyed this episode and appreciate you taking the time to listen to the show. We hope you've you got some value if you did, then we'd love it if you shared the episode. We look forward to you joining us next week for another I Hate Numbers episode.