Financial information is presented below:
Operating expenses $ 28,000
Sales returns and allowances 7,000
Sales discounts 3,000
Sales revenue 150,000
Cost of goods sold 98,000
Gross profit would be
a. $49,000.
b. $42,000.
c. $45,000.
d. $52,000.
The correct answer and explanation is :
To find gross profit, we use the formula:
Gross Profit = Net Sales – Cost of Goods Sold
Let’s break it down using the financial information provided:
Step 1: Calculate Net Sales
Net Sales = Sales Revenue – Sales Returns and Allowances – Sales Discounts
Given:
- Sales Revenue = $150,000
- Sales Returns and Allowances = $7,000
- Sales Discounts = $3,000
So,
Net Sales = $150,000 – $7,000 – $3,000 = $140,000
Step 2: Subtract Cost of Goods Sold (COGS)
Now, use the Net Sales to calculate Gross Profit:
Gross Profit = Net Sales – Cost of Goods Sold
Gross Profit = $140,000 – $98,000 = $42,000
Final Answer:
b. $42,000
Explanation (300+ words):
Gross profit is a critical financial metric that represents the profit a company makes after deducting the costs associated with producing or purchasing the goods it sells. It does not consider other expenses like operating expenses, taxes, or interest—only direct costs of goods sold (COGS) are deducted from net sales.
To arrive at gross profit, we must first calculate net sales, which represents actual revenue from customers after accounting for any product returns and sales-related discounts. This gives a more accurate measure of revenue than gross sales alone.
In this case, the company had gross sales revenue of $150,000. However, some of those sales were either returned by customers ($7,000) or had discounts applied ($3,000), which reduce the total revenue the company actually retained. Subtracting those amounts gives us net sales of $140,000.
Next, the Cost of Goods Sold (COGS) is subtracted. COGS includes all direct costs associated with making the product, such as raw materials and labor. Here, the COGS is $98,000.
Thus:
- Net Sales = $140,000
- COGS = $98,000
- Gross Profit = $140,000 – $98,000 = $42,000
It’s important to note that operating expenses like administrative salaries, rent, and utilities (in this case, $28,000) are not included in the gross profit calculation. They are considered in the next stage, when calculating operating profit (EBIT).
Understanding gross profit helps stakeholders evaluate how efficiently a company produces or sources its goods, a key indicator of financial health.