How to calculate gross profit and gross margin
Who it is forGrocery chain finance, buying, category management, store managers
Gross profit is the simplest formula in retail and the most argued-over number. Simple, because it has two components; argued-over, because what goes into those two components differs from business to business. Does distribution-centre-to-store delivery belong in cost of goods sold, does a supplier volume rebate raise gross profit, in which month is the cost of a written-off item recorded? This guide covers the formula, the conversions and why the same data produces four different gross profit figures.
What gross profit is and how it is calculated
Gross profit is the difference between the revenue from selling a product and the cost of sourcing it. Rent, payroll and utilities do not enter this calculation; they are deducted below gross profit on the way to operating profit.
Both components need definition. Net sales is gross sales less returns, discounts and VAT. Cost of goods sold is the purchase cost of the item sold plus the direct costs of making it saleable.
That second definition is the point most often skipped. When freight, customs, insurance and import charges are not allocated into product cost, gross profit comes out systematically high; the real margin sits several points below the reported one.
- Gross profit
Net sales − Cost of Goods Sold- Gross margin
Gross profit ÷ Net sales × 100- Mark-up
Gross profit ÷ COGS × 100- Unit gross profit
Selling price (excl. VAT) − Unit cost
VAT never enters a gross profit calculation, on either side. Both sales and cost are taken excluding VAT.
Margin or mark-up: one product, two numbers
The gross profit amount is a single figure, but it is expressed as a ratio in two ways. Margin divides gross profit by sales, mark-up divides it by cost. On a product costing ₺620 and selling for ₺1,000, margin is 38 per cent and mark-up is 61.3 per cent.
Which one is used depends on the language of the business and both are legitimate. The problem is when both languages appear in the same meeting: if buying says "we put 50 per cent on" meaning mark-up while finance says "33 per cent margin" about the same product, they are describing the same price and nobody realises it.
Conversion between the two is one line. Stating in the header of a price list which ratio it carries removes the confusion entirely.
- Margin → mark-up
Margin ÷ (1 − Margin)- Mark-up → margin
Mark-up ÷ (1 + Mark-up)- Price from cost
Cost ÷ (1 − Target margin)
| Gross margin | Equivalent mark-up | Selling price of a ₺100 cost item |
|---|---|---|
| 20% | 25% | ₺125 |
| 30% | 42.9% | ₺142.90 |
| 38% | 61.3% | ₺161.30 |
| 50% | 100% | ₺200 |
| 60% | 150% | ₺250 |
Initial margin versus achieved margin
Margin calculated on the ticket price is initial margin and it is known at the moment of purchase. Achieved margin only emerges once the product has actually sold, and between the two sit markdowns, shrinkage, staff purchases and returns.
On short shelf life lines the gap between the two easily reaches several points: markdowns on items approaching expiry and the write-off of items past their date erode the ticket-price margin step by step. A business that builds its annual budget on initial margin repeats the same variance every year.
The correct approach is to plan the markdown allowance up front and build the budget on achieved margin. The markdown and write-off rate of past periods is already known; it is not an unknown number, only an unused one.
How the same data produces four gross profit figures
It is not unusual for four different gross profit figures to circulate in one meeting. All four are calculated from the same sales and all four are correct within their own definition.
The source of the differences is single: which items are included in cost of goods sold. The list below shows step by step how the same ₺1,000,000 of sales produces four different gross profits.
- Invoice cost — the right basis for supplier negotiation
- Landed cost — the right basis for pricing and margin targets
- Logistics-inclusive cost — the only valid basis for comparing stores and categories
- Net achieved — the right basis for budgeting and profitability reporting
| Definition | What COGS includes | Gross profit | Margin |
|---|---|---|---|
| Invoice cost | Purchase invoice only | ₺440,000 | 44.0% |
| Landed cost | + Freight, customs, insurance | ₺380,000 | 38.0% |
| Logistics-inclusive cost | + DC-to-store delivery, handling | ₺295,000 | 29.5% |
| Net achieved | + Shrinkage, return cost, write-offs | ₺268,000 | 26.8% |
All four definitions are needed; what is wrong is not writing down which one is being used. The definition belongs in the report header.
Gross profit and net profit
Gross profit is profit before operating expenses. Rent, payroll, energy, depreciation and marketing sit below it on the way to operating profit. Deduct financing costs and tax from operating profit and you reach net profit.
In retail, a high gross margin is not good news on its own. A store running at a 45 per cent gross margin with a 15 per cent rent ratio and an 18 per cent payroll ratio reaches operating profit at 12 per cent; a store at 28 per cent margin with 20 per cent costs lands close to the same place.
Which is why a margin target is never set independently of the cost structure. The correct sequence: measure the cost base, set the target operating profit, and work back to the gross margin required.
- Operating profit
Gross profit − Operating expenses- Required gross margin
Target operating margin + Operating expense ratioAll expressed as a percentage of net sales, on the same base.
Frequently asked questions
- How is gross profit calculated?
- Cost of goods sold is subtracted from net sales. With net sales of ₺1,000,000 and cost of goods sold of ₺620,000, gross profit is ₺380,000. Net sales is stated excluding VAT and net of returns and discounts.
- How is gross margin calculated?
- Gross profit is divided by net sales and multiplied by a hundred. With ₺380,000 gross profit on ₺1,000,000 net sales, gross margin is 38 per cent. Dividing the same gross profit by cost gives mark-up: 380,000 ÷ 620,000 = 61.3 per cent.
- Is VAT included in the gross profit calculation?
- No. Both sales and cost are taken excluding VAT. VAT is not the business's revenue but an amount collected on behalf of the state; mixing it in artificially raises or lowers the margin.
- What is the difference between initial margin and achieved margin?
- Initial margin is calculated on the ticket price and is known at purchase. Achieved margin emerges after markdowns, shrinkage and returns. On short shelf life lines, expiry markdowns and write-offs widen the gap, so budgets should be built on achieved margin.
- What is the difference between gross profit and net profit?
- Gross profit deducts only product cost. Net profit is what remains after rent, payroll, energy, depreciation, financing costs and tax. A high gross margin does not translate into net profit if the cost structure is heavy.