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Definition

Gross Profit is the different between the sale prices and the cost of buying or producing the goods. It is calculated as

Gross Profit = Revenue - Cost of Goods Sold

Gross Profit is the numerator in the calculation of Gross Margin:

Gross margin
= Gross Profit / Revenue
= (Revenue - Cost of Goods Sold) / Revenue

A positive Gross Profit is only the first step for a company to make a net profit. The gross profit needs to be big enough to also cover related labor, equipment, rental, marketing/advertising, research and development and a lot of other costs in selling the products.

Formula

Gross Profit = Revenue - Cost of Goods Sold

Explanation

Warren Buffett believes that firms with excellent long term economics tend to have consistently higher margins.

Durable competitive advantage creates a high Gross Margin because of the freedom to price in excess of cost. Companies can be categorized by their Gross Margin

1. Greater than 40% = Durable competitive advantage
2. Less than 40% = competition eroding margins
3. Less than 20% = no sustainable competitive advantage
Consistency of Gross Margin is key

Related Terms

Revenue, Cost of Goods Sold, Gross margin

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