In business and finance, gross profit or gross income is used to calculate gross margins for a company. Dividing gross income by revenue determines gross margins. The gross income figure of a firm is of little use to an outsider by itself. Conversely, gross margins provide information on how well a business is performing.
Defining Gross Income
Gross income is defined as income from all sources, which can include compensation, royalties, dividends, annuities and pensions, among others. For a business, gross income generally includes all revenues taken in, minus costs of goods sold. In addition, gross income for a business does not include expenses for salaries, taxes, interest and other indirect costs.
Defining Gross Margin
Gross margin or gross profit margin equals sales minus the cost of goods sold, divided by sales. Expressed as a percentage, the gross margin in simple terms is gross profit divided by net sales. Gross profit equals gross income, which is income before an accounting for indirect costs. The terms are often used interchangeably and refer to the same figure in a firm's financial records.
Evaluating Gross Income
Gross income or gross profit, one of the figures used to calculate gross margins, includes the total revenue received before indirect costs are deducted. To translate gross income into net income, multiple expenses, such as payroll, taxes, interest on debt, preferred dividends and rent are taken from gross income to figure out real profits. Evaluating gross income along with operating expenses provides an understanding of how well the firm uses available resources.
Calculating Gross Margins
Net sales alone provide little insight into how well a company is doing. Cost of goods sold (COGS) in relationship to net sales explains much more about a business' performance. For example, assume a firm sells $5 million in merchandise, and the cost to produce or acquire the goods equals $4.5 million. The gross profit margin would be 10 percent, because net sales minus COGS equals $500,000 and $500,000 (gross profit) is 10 percent of $5 million. Conversely, a firm with $1 million in net sales that pays $500,000 for cost of goods would have a gross margin of 50 percent, a huge increase over the first example.
- "Finance: Investments, Institutions, Management"; Stanley G. Eakins, 2005
- Cornell University Law School: United States Code Title 26,61 Gross Income Defined
- "Investment Analysis and Portfolio Management"; Fifth Edition; Frank K. Reilly and Keith C. Brown; 1997
- Principles of Accounting: Chapter 5 Special Issues for Merchants
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