Gross Profit Vs Operating Profit
Gross Profit
Gross Profit is the profit that company makes after deducting the cost of goods sold from sales. It is also known as gross margin. It is not yet taken into account any operating expenses.
It is the difference between sale and cost of goods sold. The company will be able to manage the gross profit by setting the selling price and controlling the production cost.
Sale refers to the gross amount which arrives from the selling quantity multiply by the price. It excludes sale discount, damage, and any other sale return. To calculate the gross profit, we need to use the net sale which is net off with both items above. As the selling price is fixed, so the number of sales will depend on the sale quantity.
Cost of goods sold refers to all relevant items that are necessary to produce the product. It includes direct material, direct labor, and other variable overhead. Cost of goods sold only takes into account the cost of products that have already been sold, so it will fluctuate depending on the sale quantity.
Both revenue and cost of goods sold are present at the beginning of the income statement. While we can find gross profit or gross margin on the company’s income statement, it is the remaining balance after deducting the cost of goods sold from total sales.
Gross Profit Formula
Gross Profit Equal to a total sale less cost of goods sold.
| Gross Profit = Total Sale – Cost of Goods Sold |
- Total Sale: is the total amount that a company generates from the sale of goods or services which takes into account sale discount and sale return.
- Cost of goods sold: refers to the cost related to acquiring or manufacturing inventories and make them ready for sale. It represents direct material, direct labor, and other overhead allocated to each product.
For example, company ABC makes total sales of $ 220,000 during the year. However, there is a sale return of $ 20,000 due to the quality issue. The quality team has inspected the goods and agreed to accept the sale return and refund the balance. In the same year, the accountant has calculate the cost of goods sold at $ 60,000.
First, we need to calculate the net sale which is equal to gross sale adjusted with discount and sale return.
Net sale = $ 220,000 – $ 20,000 = $ 200,000
We have to exclude the sale return as it is subsequently deducted from the company revenue. We only use the net sale that company makes.
So the gross profit = $ 200,000 – $ 80,000 = $ 120,000
Gross profit equal to 60% of sale (120,000/200,000 = 60%). It means that 40% of sales will be charged as the cost of goods sold, only the remaining 60% will be deducted for profit.
We can calculate the gross profit by multiplying the net sale with the gross profit percentage.
Gross profit = $ 200,000 * 60% = $ 120,000
Operating Profit
Operating profit is the profit that company makes after deducting the cost of operation from total revenue. Cost of operation includes the cost of goods sold, fixed cost, and other costs that are necessary to operate the business activities and provide goods or services to customers.
It is the profit that company makes after paying for the expenses related to the core business operation. We can calculate the gross profit that arrives from sales less cost of goods sold and other expenses necessary to run the business. The operating expense also includes non-cash expenses such as depreciation and amortization expense.
Operating profit excludes the finance cost and income tax expense. These are non-operating expenses that are not under the control of the company. Finance cost is the interest expense that fluctuates due to the market rate. When the market rate decrease, company can borrow cash at a lower cost and the other way around. Moreover, the income tax expense will depend on the government, we cannot negotiate the tax rate with the government.
Operating profit is always less than the gross profit as it requires deducting the operating expense. We can calculate the operating profit by deducting the operating expense from the gross profit. It helps management to analyze the company actual performance by excluding any non-operating expense.
Operating Profit Formula
Operating profit equal to a total sale less cost of goods sold and operating expenses.
| Operating Profit = Total Sale – Cost of Goods Sold – Operating Expenses |
- Operating Expenses: is the expense incurred due to normal business activities. It includes payroll expenses, rentals, administrative, marketing, and so on.
Continue from above example, company spends around $ 100,000 on operating expenses such as payroll, utilities, admin expenses, and other expenses.
Operating Profit = Sale – COGS – Operating Expense
= $ 200,000 – $ 80,000 – $ 100,000 = $ 20,000
It means that company generates $ 20,000 of operating profit which represents 10% over sale revenue.
Difference Between Gross Profit and Operating Profit
| Gross Profit | Operating Profit | |
|---|---|---|
| Formula | = Sale – COGS | = Sale – COGS – Operating Expenses |
| Expenses include | It includes COGS which take into account the raw material, direct labor, and other direct overhead. | It is based on COGS and operating expenses. The operating expenses include payroll, rental, utilities, and other expenses necessary to operate the business. |
| Benefit | To measure company operational efficiency. | To measure company operating performance. |