Gross profit in a business is the amount of money that is left over from the sale of an item, after the cost of goods sold is subtracted. It is often expressed as a percentage of the sale. This is the amount of money that is available to pay for all other business expenses, such as rent and salaries, as well as a profit or return for the owners of the business. A critical but sometimes misunderstood skill is the ability to calculate a selling price from the cost of goods sold at a given gross profit percentage.
1. Determine the desired gross profit margin for the product. Check to see what other similar businesses average for gross profit margins, and set your desired gross profit margin within that range. If you set your profit margin incorrectly, you could be left short on funds to cover expenses, or you may be pricing your product too high in comparison with the competition. The higher pricing could cause customers to defect, and in turn reduce your sales.
2. Establish the cost of goods sold for an item. If you have a retail business that re-sells items purchased from wholesalers, the invoiced price determines the cost of goods sold. If you manufacture or recondition items for re-sale, you will need to calculate how much money you spend to produce the item to determine your cost of goods sold. Include any material costs, as well as the cost of direct labor to produce the item. Do not include any other selling costs or general business expenses not directly attributable to the production of the merchandise.
3. Subtract the desired gross profit percentage from 1. For example, if your business wants to achieve a 40 percent gross profit margin, you would subtract 0.40 from 1, for a difference of 0.6. Divide the cost of the item by the result of this calculation. If the merchandise costs $100, you would divide $100 by 0.6. The "quotient" is the selling price required to achieve the given gross profit. In this case, $166.67 is the necessary selling price.
- If you double the cost of goods sold, and use that figure as a selling price, the selling price would be at a 50 percent gross profit. This is a reference that allows you to quickly know if an item is over or under the 50 percent gross mark.
- Do not confuse gross profit with markup. Markup is the amount that is added to the cost of the product to arrive at the selling price. Markup is expressed as a percentage in relationship to the cost of goods, and gross profit is expressed as a percentage in relationship to the selling price.