Gross Profit Guide and ExamplesGross profit is the difference between Sales and the Cost of Goods Sold (COGS). It is a measure of a company's core activities, and is an early measure of business strength. For example, Sunny Sunglasses Shop sells a pair of sunglasses for $50 retail. Sunny is able to purchase these sunglasses for $15 each wholesale (COGS). Sunny therefore made a healthy profit of $35 ($50-$15=$35). The COGS in this case is $15. This translates into a strong profit margin of 70%.
In analyzing how Sunny achieved a profit in his business, the profit margin is a key measurement. Sunny managed to negotiate a competitive wholesale price for a quality product that retails for $50. A strong profit margin is crucial to business success since it represents profit before operating expenses and taxes enter the picture. Let's see how Sunny Sunglasses Shop's gross profit margin compares with other companies and its industry, Specialty Retail, Other:
Sunny wisely selected a business with a strong profit margin, getting his profits off to a jump start before operating expenses and taxes. It is right in line with his closest and largest competitor, Luxottica, and well ahead of the industry average of 36.4% for Specialty Retail.
Sunny should monitor this key indicator of profits from year to year to ensure he remains profitable, and note any reasons why his profit margins are going up (e.g. wholesale discounts, in demand products and higher prices) or down (e.g. more expensive inventory, discounted retail items, and lower demand for products).A small percentage of Sunny Shop's customers will return products sold. Note that gross profit is divided by sales after returns, or net sales, not gross sales. Sunny selected a business with an impressive gross margin. His next step is to make sure he holds on to his profits by controlling operating expenses.
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