Quick answer
Gross profit is what's left from your sales after you subtract the direct cost of making or buying what you sold, such as materials, stock and direct labour. Overheads like rent, admin wages and loan repayments come out later. Lenders watch gross profit, and especially gross margin (gross profit as a percentage of sales), because it shows whether the core of the business makes money before fixed costs.
Key points
- Gross profit = sales (excluding GST) minus cost of goods sold
- Gross margin expresses it as a percentage of sales and is easier to compare year to year
- Overheads, owner drawings, interest and tax are not deducted at this stage
- A falling gross margin is one of the first things a credit assessor will question
Of all the lines on a profit and loss statement, gross profit is the one that tells you whether each sale is worth making. In short: it’s revenue minus the direct costs of earning that revenue, before overheads, interest or tax.
The formula
Gross profit = sales − cost of goods sold (COGS)
Gross margin = gross profit ÷ sales × 100
Both figures should exclude GST. “Cost of goods sold” is accountant’s language that also covers service businesses, where it usually means materials, subcontractors and the labour directly billed to jobs.
A worked example: a plumbing business
A Geelong plumbing company has these figures for the last financial year:
| Amount | |
|---|---|
| Sales (excluding GST) | $900,000 |
| Materials and fittings | $310,000 |
| Subcontractors | $120,000 |
| Wages of plumbers on the tools | $90,000 |
| Cost of goods sold | $520,000 |
| Gross profit | $380,000 |
| Gross margin | 42.2% |
From that $380k, the business still has to pay the office manager, vehicle running costs, insurance, software, rent on the yard and any loan repayments. If those operating expenses total $260k, net profit before tax is about $120k.
Now suppose copper prices jump and the owner doesn’t lift quotes. Materials rise to $360k on the same sales, gross profit drops to $330k and the margin falls to 36.7%. Overheads haven’t moved, so net profit shrinks by $50k, more than 40%, from a cost rise of about 16% on one line. That leverage is why lenders pay such close attention to this number.
How lenders use gross profit
A credit assessor reading your financials will usually:
- Track the margin over two or three years. Stable or rising is reassuring. A slide raises questions about pricing power, cost control or competition.
- Compare it with your industry. A margin far above peers may prompt a closer look at how costs are classified.
- Check it covers fixed costs plus the new repayment. Gross profit is the pool that everything else, including the loan, is paid from.
- Look for seasonality. Monthly management accounts can show margins dipping in slow months, which matters for weekly or daily repayment products.
Banks typically want full financials and tax returns to see this properly. Where your accountant is behind, some non-bank lenders work from bank statements and BAS instead, though they’ll still form a view of how profitable your sales are.
Need finance and your margins tell a good story? Send a short enquiry and we’ll show you what they support.
Gross profit vs markup
These get confused often. Markup measures gross profit against what the item cost you; margin measures it against what the customer paid. Buying an item for $60 and selling it for $100 is a 66.7% markup but a 40% margin. Pricing on markup while budgeting on margin is a common source of nasty surprises. Our margin and markup calculator switches between the two, while our break-even calculator shows how many sales your margin needs to cover fixed costs.
Related terms
EBITDA, profitability, turnover and cash flow are the next steps down the page from gross profit.
Healthy margins, tight cash?
Plenty of profitable businesses still hit cash gaps while they wait to be paid or stock up for a busy season. If that’s you, an enquiry with us is a sensible next step. It’s quick (around sixty seconds) and makes no mark on your credit history. A specialist on our team, a real person, reviews it and rings you, and nothing gets broadcast to a crowd of lenders. Getting turnover and purpose right on the form means the first suggestion should be the one that fits.
Frequently asked questions
What's the difference between gross profit and net profit?
Gross profit only deducts the direct costs of sales. Net profit goes further and deducts every other expense too, including rent, wages for non-production staff, insurance, interest, depreciation and tax. A business can have a strong gross profit and still make a net loss if its overheads are too high.
What counts as cost of goods sold?
Costs that rise and fall with each sale: stock bought for resale, raw materials, packaging, freight inwards, subcontractors and, for some businesses, wages of staff who directly produce the goods or deliver the jobs. Your accountant decides the exact split, so ask them to keep it consistent from year to year.
Is a higher gross margin always better?
Generally it means more room to cover overheads and repayments, but it depends on the industry. A wholesaler moving high volumes can run on a thin margin, while a consultancy might expect a very high one. Lenders compare you with similar businesses and with your own history.
Should gross profit be calculated with or without GST?
Without. If you're registered for GST, the GST you collect belongs to the ATO and the GST on purchases is usually claimed back, so both sales and costs should be shown exclusive of GST.
Can I improve gross profit before applying for a loan?
Over a few months, yes, by reviewing prices, cutting waste or renegotiating supplier costs. Lenders look at trends across statements, so a genuine improvement shows up best when it's sustained rather than a one-off quarter.