Gross Profit

A company takes in money through sales. This total is called revenue. But to manufacture the products or provide the service, it must itself spend money: on materials, on components, on the people in production, on electricity for the factory. If you subtract these direct costs from revenue, what remains is gross profit. It answers a simple question: Does the company actually earn anything from what it sells? Everything else – office rent, advertising, interest on loans, taxes – has not yet been factored in at this point.

What gross profit reveals about a business model

Gross profit is usually expressed as a percentage of revenue. This figure is called the gross margin. It is one of the most telling figures in a business report, because it is very hard to dress up. A high gross margin means that every additional unit sold leaves a lot of money left over.

The differences between industries are enormous. A supermarket often achieves only 20 to 30 percent, because it buys goods and resells them with a small markup. A software company, by contrast, frequently reaches 70 to 90 percent. The reason is easy to understand: developing a program once is expensive, but delivering it to the millionth customer costs almost nothing.

An important misconception: gross profit is not profit. A company can have a brilliant gross margin and still post deep losses if it spends too much on advertising or research. Gross profit therefore only shows how healthy the core business is – not whether any money is left over at the end of the year.

The calculation step by step

The formula is: revenue minus the cost of goods sold. These production costs are called COGS in English, short for “cost of goods sold.” This includes everything that would not have arisen without the sale: raw materials, purchased parts, wages in production, shipping costs.

A numerical example: A company sells headphones for 200 euros each. Manufacturing, components, and shipping cost it 80 euros. The gross profit is 120 euros, so the gross margin is 60 percent. If it sells 100,000 units, that results in 12 million euros of gross profit. From that, it still has to pay for development, marketing, and administration.

The distinction becomes tricky with services and software. What counts as direct costs, and what doesn’t? For a cloud provider, server costs are included, but programmers' salaries usually are not. Because companies have a certain amount of leeway here, analysts prefer to compare gross margin over several years within the same company rather than between two different companies.

Why the figure is a hot topic among AI companies right now

In the quarterly reports of publicly traded companies, gross profit ranks high up. If the gross margin drops by just a few percentage points, the stock price often reacts sharply. That’s because a declining margin suggests that materials are getting more expensive, that competition is driving down prices, or that the company has to offer discounts just to make sales at all.

The metric is especially interesting right now for providers of AI services. Classic software had dreamlike margins because making a copy costs almost nothing. With a chatbot, it’s different: every single response consumes computing time on expensive specialized chips. These costs recur with every use and directly weigh down gross profit.

That’s why business news often reports that an AI company has rapidly growing revenue but weak margins. This is precisely why these companies are working so intensively to make their models cheaper to operate. Every cent saved per request lands directly in gross profit.