Gross Profit in Accounting: How to Calculate It Step by Step

Gross profit is the money left after subtracting direct costs from net sales.

It is one of the quickest ways to see whether your products or services are priced correctly and whether direct costs are under control.

Many Malaysian business owners understand revenue and expenses, yet gross profit still feels confusing because of inventory, discounts, or mixed revenue streams.

So today, our accounting firm will cover the formula, the examples, common mistakes, and the usage of calculating GP so you can sleep soundly at night. Let’s get to it.

How Do You Calculate Gross Profit Step by Step?

Gross profit equals net sales minus the cost of goods sold.

The calculation looks simple, but it only works correctly when both numbers are recorded in the right way.

Formula

Gross Profit = Net Sales – Cost of Goods Sold (COGS)

Step by Step

1. Record net sales (total sales after discounts, returns, and allowances).
2. Determine COGS for the same period.
3. Subtract COGS from net sales.
4. The result is gross profit.
5. For margin, divide gross profit by net sales and multiply by 100.

It’s really that simple but as mentioned, both of your net sales and COGS must be accurate.

What Counts as Net Sales in a Gross Profit Calculation?

Net sales represent the actual recognised revenue for the period after discounts, returns, and allowances. 

This applies whether customers pay immediately or later, but only for goods or services already delivered or performed. 

Unfulfilled orders are not counted in net sales until control transfers to the customer.

Net Sales Include

• Revenue from goods or services delivered during the period
• Less discounts applied at point of sale or invoice
• Less customer returns
• Less allowances or negotiated adjustments

How Do Delayed Payments Affect Net Sales?

Net sales are based on revenue earned, not when the cash arrives.

Delayed payment does not change the calculation because gross profit follows the accrual concept.

If goods or services have already been delivered, revenue is counted even if the customer pays next week or next month.

Example: Customer Pays Late

• Goods delivered in March: RM12,000
• Customer pays in April
• March Net Sales still include RM12,000

The cash timing does not affect gross profit for March. It only affects your receivables.

How Do Deposits Affect Net Sales?

Deposits are recorded as liabilities until delivery occurs.

They do not count toward net sales until the business has delivered the product or performed the service.

Example: Deposit Collected

• Customer pays RM5,000 deposit for upcoming catering
• Event happens next month
• Net Sales for this month do not include RM5,000
• Full revenue is recognised when the catering is completed

Simple Example

If you sold RM50,000 in goods with RM2,000 in discounts and RM500 in returns:

Net Sales = RM50,000 – RM2,000 – RM500 = RM47,500

This treatment applies regardless of whether customers paid immediately or on credit terms.

What Counts as COGS for Gross Profit?

COGS includes only the direct costs required to produce or deliver what you sell.

It must match the same period as your net sales so the gross profit calculation stays accurate.

Direct Costs Usually Include

• Opening inventory
• Purchases during the period
• Freight inwards or delivery-to-store costs
• Direct labour tied to production or service delivery
• Direct materials
• Closing inventory, which is subtracted at the end

COGS Formula

COGS = Opening Inventory + Purchases + Direct Costs – Closing Inventory

This formula makes sure you recognise only the cost of items actually sold, not all items purchased.

How Do Partial Deliveries Affect COGS?

Only the portion of stock received and usable is counted.

Example: Partial Supplier Delivery

• Ordered RM10,000 of stock
• Supplier delivers RM6,000 this month and the rest next month
• Only RM6,000 enters inventory and COGS calculations this month
• Remaining RM4,000 belongs to the next period

If part of a shipment is damaged or rejected, only the accepted portion is included.

How Do Supplier Credits Affect COGS?

Credits reduce the cost of purchases.

Example

• Purchased RM12,000 of materials
• Supplier issues RM1,500 credit due to quality issues
• Net purchase cost in COGS becomes RM10,500

This prevents overstating your direct costs.

How Do Prepaid Purchases Affect COGS?

Prepayment alone does not affect COGS. Stock must be received first.

Scenario

You pay RM8,000 upfront for future stock.

• If goods have not arrived, nothing enters inventory
• COGS remains unchanged
• The RM8,000 sits as a prepaid asset until stock is delivered

Gross profit only changes once the inventory is available for use or sale.

How Do Consignment or Supplier-Held Goods Affect COGS?

Consignment stock is not recorded as inventory until taken for sale.

Scenario

A supplier places RM30,000 of stock in your store on consignment.

• Inventory remains zero until you sell the item
• When you sell, you record only the cost of the sold item as COGS
• Unsold consignment stock does not inflate inventory or purchases

This prevents inventory bloating and keeps gross profit realistic.

How Does Production Labour Affect COGS?

Only labour directly tied to production belongs in COGS.

• Bakers making bread
• Technicians servicing equipment
• Kitchen staff preparing food
• Manufacturing line workers

Important Clarification: Admin salaries and marketing do not belong in COGS. However, factory-related costs (such as production rent and utilities, indirect production labour) are manufacturing overheads under IAS 2. 

Read more: How to Start a Profitable Vending Machine Business in Malaysia

How Do You Calculate Gross Profit for Different Types of Businesses?

1. Product-Based Business

Gross profit relies heavily on accurate inventory movement.

Example: Retail Shop (

• Net Sales: RM80,000
• Opening Inventory: RM20,000
• Purchases: RM35,000
• Closing Inventory: RM18,000

COGS = 20,000 + 35,000 – 18,000 = RM37,000

Gross Profit = 80,000 – 37,000 = RM43,000

A small shop running monthly promotions may have fluctuating sales, so tracking inventory correctly keeps gross profit figures reliable even when discounting varies.

2. Service Business

Since there is no inventory, COGS focuses on direct service delivery costs.

Direct Costs May Include

• Technician or project staff labour
• Materials consumed during service
• Subcontractor fees tied to the job

Example

Net Sales = RM30,000
Direct Labour and Materials = RM9,000
Gross Profit = 30,000 minus 9,000 = RM21,000

A cleaning company with fixed hourly teams tracks direct labour per job to see which contract types produce healthy gross profit.

3. Hybrid Business (Product plus Service)

Both inventory and labour need proper classification.

Example: Café Selling Food and Catering Services

• Net Sales: RM120,000
• Direct Food Costs: RM45,000
• Catering Labour: RM12,000
• Total COGS: RM57,000

Gross Profit = 120,000 – 57,000 = RM63,000

Cafés often mix dine in, takeaway, and catering. A clear separation helps identify which line of revenue generates stronger margins and adjust your strategies accordingly.

What Is the Difference Between Gross Profit and Gross Profit Margin?

Gross profit is a number while gross profit margin is a percentage.

Example

• Gross Profit = RM40,000
• Net Sales = RM100,000
• Gross Profit Margin = 40%

What Are Common Mistakes When Calculating Gross Profit?

Most errors come from misclassifying costs or ignoring inventory changes.

Frequent Issues

• Recording rent, utilities, or admin salaries as COGS (These are overhead)
• Forgetting to adjust for closing inventory
• Missing freight inwards when it is a direct cost
• Applying discount figures inconsistently across sales periods
• Combining service revenue and product revenue without separating their respective costs.

Run a monthly internal review comparing gross profit by product line or service type. This reveals gaps long before year end closes.

How Can Businesses Use Gross Profit to Improve Decisions?

Gross profit shapes pricing, purchasing, and daily operations. But it also helps give business a clearer picture of their operations and expenditures. Perhaps the raw materials costs are increasing, or perhaps margins aren’t covering rent and labour.

• Assess whether prices cover direct costs comfortably
• Compare suppliers and negotiate when costs change
• Evaluate discount strategies and promotion timing
• Identify weak products that drain resources
• Forecast profitability before accepting large orders

“If a café notices gross profit falling even with steady sales, it may indicate rising ingredient costs or waste issues. Early detection allows timely menu adjustments.”

Is There a Simple Gross Profit Template or Calculator You Can Use?

Yes. A basic gross profit sheet includes four fields:

However, there are accounting software tools that do the calculations for you. We even have a top 10 accounting software in Malaysia for businesses of all sizes, go check it out!

Calculating Your Gross Profit is Part of the Story

Gross profit reveals far more than a simple number. It shows if your pricing is sustainable, whether your direct costs are moving in the right direction.

Once net sales and COGS are recorded correctly, patterns become clear and your costs suddenly make sense.

But if you prefer to focus on running the business while someone else handles the numbers, Accounting.my can help. We provide:

• Precise bookkeeping
• Monthly reporting
• Audit support 

So your financial data is organised, compliant, and ready for confident planning.

Source:

• IFRS 15: Revenue from Contracts with Customers (IFRS Foundation, official standard PDF, 2021).
• MFRS 15 overview (PwC Malaysia) — 5-step model & Malaysian context.
• Contract assets & liabilities explainer (ACCA) — deposits as contract liabilities.
• IFRS 15 consignment guidance for retailers (PwC, PDF). 
• IAS 2: Inventories (IFRS Foundation, official standard PDF, 2022). 
• CFI — “Net Sales: Overview, Formula and Components.”