Gross profit, operating profit and profit for the year

Three measures of profit

• Gross profit = revenue - cost of sales. Cost of sales is the direct cost of the goods sold (materials, goods bought for resale, direct labour). It shows how well the firm buys or makes and prices its products.
• Operating profit = gross profit - operating expenses (overheads such as rent, salaries, marketing, administration, depreciation). It shows the profit from the firm's main trading activities.
• Profit for the year (net profit) = operating profit - finance costs (interest) - tax, plus any finance income. It is what is left for the owners: paid as dividends or retained.

An invented company's year

Ways to increase profit

Profit = revenue - costs, so:

• Raise revenue: increase sales volume (promotion, new markets, better distribution) or raise price where demand is price inelastic.
• Cut cost of sales: cheaper suppliers, bulk buying, less waste, more efficient production.
• Cut overheads: cheaper premises, fewer managers, energy saving, moving sales online.

Each has risks: a price rise may lose customers; cheaper materials may damage quality and reputation; cutting staff may hurt service and motivation.

Using the figures

Compare the levels. If gross profit is healthy but operating profit is low, overheads are the problem. If operating profit is fine but profit for the year is small, heavy interest payments (high borrowing) are eating into it. Comparing with previous years and competitors shows whether performance is improving.

Worked example

Using the statement in step 1, show how each profit figure is found.

1. Gross profit = 900,000 - 540,000 = $360,000
2. Operating profit = 360,000 - 210,000 = $150,000
3. Profit for the year = 150,000 - 15,000 - 27,000 = $108,000

Answer: Gross $360,000, operating $150,000, profit for the year $108,000

Check yourself

1. Revenue is $450,000 and cost of sales is $270,000. Calculate gross profit.
   Show answer

   $180000. 450,000 - 270,000 = $180,000.

2. Gross profit is $180,000 and operating expenses are $125,000. Calculate operating profit.
   Show answer

   $55000. 180,000 - 125,000 = $55,000.

3. Operating profit is $55,000, interest is $8,000 and tax is $9,400. Calculate profit for the year.
   Show answer

   $37600. 55,000 - 8,000 - 9,400 = $37,600.

4. A shop sells 12,000 items at $15 each. Each item costs $9 to buy from the supplier. Calculate gross profit.
   Show answer

   $72000. Revenue 180,000 - cost of sales 108,000 = $72,000.

5. Gross profit is $310,000 and operating profit is $95,000. What were operating expenses?
   Show answer

   $215000. 310,000 - 95,000 = $215,000.

6. Which cost is part of cost of sales for a clothing retailer?
   • Rent on the head office
   • Salaries of the marketing team
   • The cost of the clothes bought from suppliers
   • Interest on a bank loan
   Show answer

   The cost of the clothes bought from suppliers. Cost of sales is the direct cost of the goods sold.

7. A firm's gross profit is rising but its operating profit is falling. The most likely cause is
   • rising overheads such as rent and salaries
   • rising cost of sales
   • falling revenue
   • rising tax
   Show answer

   rising overheads such as rent and salaries. Operating profit falls below gross profit by the overheads.

8. Explain one risk of increasing profit by switching to a cheaper supplier.
   Show answer

   The cheaper materials may be lower quality, damaging the product and the firm's reputation so customers stop buying, which could reduce sales revenue.. Lower quality or reliability, so reputation and sales suffer.

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Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Business specification (2018)

Last updated 8 November 2026. Spotted a mistake? Tell us.