Deborah teaches college Accounting and has a master's degree in Educational Technology.
In addition to evaluating the financial performance of the company overall, businesses need information on the profitability of each department. In this lesson, you will learn about calculating gross profit by department.
Separating and Calculating
Ms. Rolle runs Tunes Music Store, where she focuses on selling rock, country and classical music. She knows her store is profitable overall, but she would like to know how much profit each department is making before expenses are subtracted. Let's examine how Ms. Rolle could achieve her objective.
In order to assess profitability, Ms. Rolle would generate an income statement that details the revenues and expenses that her store has incurred. 'Revenue' represents the amount of sales that she has made and 'expenses' represent the costs incurred to make the sales. If revenue is greater than the expenses, then Tunes Music store has made a profit, and if expenses are greater than revenue, then the store has lost money.
In addition to knowing the overall profit made by her company, Ms. Rolle would also be interested in the gross profit. Gross profit represents the difference between the sales revenue and the cost of goods sold. It is the mark-up on a product or service, which the profit earned before operating expenses are deducted. For example, if Ms. Rolle pays $4 to buy a CD and then sells it to a customer for $15, the gross profit (or mark-up) on that sale would be $11 ($15 - $4). Ms. Rolle also incurs other costs, including rent, utilities, salaries for her employees and advertising expenses. These expenses must be deducted from the gross profit when determining the overall profit or loss. Let's examine the income statement for Tunes Music Store for the month of May, which reports revenues and expenses.
We can see that Tunes Music Store had a gross profit of $12,000 and net income of $5,000 for the month of May, but this presentation does not tell Ms. Rolle which departments had a profit and which may have had a loss. This is where tracking and reporting gross profit by department is helpful.
Gross Profit by Department
In order to calculate gross profit for each of Tunes Music Store's three departments, Ms. Rolle would have to track the sales and costs separately in the company's general ledger. The general ledger is like a filing cabinet where all the individual accounts that are used to report the financial information are stored. For example, Ms. Rolle could have the following accounts:
Sales - Rock;
Sales - Country and
Sales - Classical.
She would also need to keep track of the cost of goods sold by department in order to calculate the gross profit. Let's assume the following information for Tunes Music Store for the month of May:
Sales - Rock: $10,000;
Sales - Country: $7,000;
Sales - Classical: $3,000;
Cost of Goods Sold - Rock: $4,500;
Cost of Goods Sold - Country: $2,500 and
Cost of Goods Sold - Classical: $1,000.
We can now calculate the departmental gross profit.
The departmental gross profit shows that the rock department had a gross profit of $5,500, country's gross profit was $4,500 and the classical department had a gross profit of $2,000.
Over 79,000 lessons in all major subjects
Get access risk-free for 30 days,
just create an account.
In addition to calculating the gross profit in dollars, Ms. Rolle would also find it useful to calculate the gross profit percentage for each department. The formula for calculating the gross profit percentage is:
Gross Profit % = (Gross Profit (in dollars) / Sales Revenue) x 100%
Ms. Rolle would want to calculate the gross profit percentage for each department as it outlines the amount that each department has left over to cover its operating expenses. A higher percentage is desirable. Let's calculate the gross profit percentage for Tunes Music Store's three departments.
These calculations illustrate that the overall gross profit percentage is 60%, and while the country and classical departments are doing better than the total at 64.3% and 66.7% respectively, the rock department is underperforming the other two departments. Since the results for the rock department are not as favorable as the other two departments, Ms. Rolle might use this information to increase her selling price for the items in the rock section to generate more sales and a higher gross profit, seek different suppliers for the products in the rock section to lower the cost of goods sold and/or increase advertising for the country and classical departments to bring in more customers since they currently have a higher gross profit.
This information could also be used to determine if a department should be closed. In this case, even though the rock department is producing less gross profit as a percentage than either the country or classical departments, it is still generating a positive gross profit, so there is no reason to close it.
Separating sales and cost of goods sold by department in the general ledger allows business owners to calculate the gross profit (sales - cost of goods sold), which represents the mark-up on its goods, and gross profit percentage (gross profit / sales revenue) x 100%) to determine which departments are profitable and which are not. In addition, this information can be used to determine whether changes in product offerings or suppliers is needed, and whether or not it would be better for the company's overall profitability to close an entire department.
Did you know… We have over 200 college
courses that prepare you to earn
credit by exam that is accepted by over 1,500 colleges and universities. You can test out of the
first two years of college and save thousands off your degree. Anyone can earn
credit-by-exam regardless of age or education level.