Accounting Gross Profit Margin Formula
Learn how gross profit, cost of goods sold, and gross profit margin are calculated from sales revenue and direct costs.
Gross profit margin estimates the share of sales revenue remaining after the direct costs of making goods or delivering services. It is useful for reviewing how much revenue is available to cover indirect expenses and, potentially, net profit.
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Gross Profit Margin
Where:
Add the direct costs to find cost of goods sold, subtract that amount from sales revenue to find gross profit, then divide gross profit by sales revenue and multiply by 100.
Variables Explained
| Variable | What It Means | Unit |
|---|---|---|
| salesRevenue - Sales revenue | Revenue from sales before deducting direct costs for the selected period. | currency |
| materialsCost - Materials or inventory cost | Cost of materials, purchased inventory, or stock associated with sales. | currency |
| directLaborCost - Direct labor cost | Wages and related employment costs directly linked to production or service delivery. | currency |
| otherDirectCosts - Other direct costs | Other costs directly connected to sales, such as subcontractors, job-specific supplies, or production freight. | currency |
| costOfGoodsSold - Cost of goods sold | Total direct cost of the revenue entered. | currency |
| grossProfit - Gross profit | Sales revenue remaining after cost of goods sold is deducted. | currency |
| grossProfitMargin - Gross profit margin | Gross profit shown as a percentage of sales revenue. | percent |
Step-by-Step Calculation
Add materials, labor, and other direct costs
This produces the total cost of goods sold, also called direct costs or cost of sales in some reports.
costOfGoodsSold = materialsCost + directLaborCost + otherDirectCosts
Calculate gross profit
Gross profit is the currency amount left after direct costs are removed from sales revenue.
grossProfit = salesRevenue - costOfGoodsSold
Convert gross profit to a margin
Dividing by revenue puts gross profit on a comparable percentage basis.
grossProfitMargin = (grossProfit / salesRevenue) * 100
Example: gross profit margin for a trading business
Calculate cost of goods sold
$35,000 + $15,000 + $10,000
$60,000
Calculate gross profit
$100,000 - $60,000
$40,000
Calculate gross profit margin
($40,000 / $100,000) * 100
40.0%
Final Result
Gross profit is $40,000, cost of goods sold is $60,000, and gross profit margin is 40.0%.
Assumptions
- ✓Sales revenue and all direct costs relate to the same accounting period.
- ✓Materials, direct labor, and other entered direct costs are treated as cost of goods sold.
- ✓Revenue is greater than zero, because a margin cannot be calculated from zero sales revenue.
- ✓Indirect overheads, administration, financing costs, and taxes are excluded.
Limitations
- !Cost classifications can differ by business, industry, accounting method, and reporting purpose.
- !A gross margin does not show operating profit, net profit, cash flow, or liquidity.
- !Inventory adjustments, returns, discounts, and accruals can affect reported results if they are not reflected in the inputs.
- !A higher margin is not automatically better without considering pricing, volume, product mix, and indirect costs.
Common Mistakes to Avoid
Using expenses from a different month, quarter, or year than the sales revenue.
Including general office rent, marketing, or administrative salaries as direct costs without using a consistent policy.
Leaving out subcontractor costs, shipping directly tied to production, or job-specific supplies.
Confusing gross profit margin with markup; margin uses sales revenue as the denominator.
Entering gross profit instead of sales revenue in the revenue field.
Related Formulas
Frequently Asked Questions
What is the formula for gross profit margin?
Gross profit margin equals gross profit divided by sales revenue, multiplied by 100. Gross profit equals sales revenue minus cost of goods sold.
How do I calculate gross profit from revenue and costs?
Subtract total direct costs, or cost of goods sold, from sales revenue.
What is the gross profit margin if revenue is $100,000 and direct costs are $60,000?
Gross profit is $40,000. Dividing $40,000 by $100,000 gives a gross profit margin of 40%.
Can gross profit margin be more than 100%?
Not under this formula when direct costs are zero or positive. A result above 100% usually indicates an input or classification issue.
Can gross profit margin be negative?
Yes. It is negative when total direct costs are greater than sales revenue for the period entered.
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