What is gross profit?

Definition of gross profit

Gross profit is a business's income, less its day-to-day running costs that relate directly to making particular sales. Running costs that relate directly to making sales are called 'direct costs' or 'cost of sales'. Running costs that don't relate directly to making sales are called 'indirect costs' or 'overheads'.

A business's gross profit divided by its sales equals its 'gross profit margin', which is a very useful indicator as it shows how much gross profit the business is making for every pound it earns in sales. Gross profit margin is always written as a percentage.

It's useful to compare this year's gross profit margin to last year's, and to compare the actual gross profit margin to how much you expected it to be according to your business plan, to see how well your business is doing. You can check your businesses profit margin easily with FreeAgent's accounting software.

Direct costs versus indirect costs

Direct costs (or 'cost of sales') might be raw materials bought to make goods to sell, or wages for factory staff.

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Indirect costs (or 'overheads') would be costs like accountancy fees, or stationery - general costs for the business, which don't relate to a given sale.

Businesses that sell services rather than goods might not have any direct costs, and so there would be no figure for gross profit on their Profit and Loss report.

Got questions? Ask Emily!

FreeAgent's Chief Accountant Emily Coltman is available to answer your questions in the comments.