After you have figured the
gross receipts from your
business (chapter 5) and the
cost of goods sold (chapter 6),
you are ready to figure your
gross profit. You must determine
gross profit before you can
deduct any business expenses.
These expenses are discussed in
chapter 8.
If you are filing Schedule C-EZ,
your gross profit is your gross
receipts plus certain other
amounts, explained later under
Additions to Gross Profit.
Businesses
that sell products. If
you are filing Schedule C,
figure your gross profit by
first figuring your net
receipts. Figure net
receipts on Schedule C by
subtracting any returns and
allowances (line 2) from
gross receipts (line 1).
Returns and allowances
include cash or credit
refunds you make to
customers, rebates, and
other allowances off the
actual sales price.
Next, subtract the cost of
goods sold (line 4) from net
receipts (line 3). The
result is the gross profit
from your business.
Businesses
that sell services.
You do not have to figure
the cost of goods sold if
the sale of merchandise is
not an income-producing
factor for your business.
Your gross profit is the
same as your net receipts
(gross receipts minus any
refunds, rebates, or other
allowances). Most
professions and businesses
that sell services rather
than products can figure
gross profit directly from
net receipts in this way.
Illustration. This
illustration of the gross
profit section of the income
statement of a retail
business shows how gross
profit is figured.
Gross receipts
$400,000
Minus: Returns
and allowances
14,940
Net receipts
$385,060
Minus: Cost of
goods sold
288,140
Gross profit
$96,920
The cost of goods sold for
this business is figured as
follows:
Inventory at
beginning of
year
$37,845
Plus: Purchases
$285,900
Minus: Items
withdrawn for
personal use
2,650
283,250
Goods available
for sale
$321,095
Minus: Inventory
at end of year
32,955
Cost of goods
sold
$288,140
Items To Check
Consider the following items
before figuring your gross
profit.
Gross
receipts. At the end
of each business day, make
sure your records balance
with your actual cash and
credit receipts for the day.
You may find it helpful to
use cash registers to keep
track of receipts. You
should also use a proper
invoicing system and keep a
separate bank account for
your business.
Sales tax
collected. Check to
make sure your records show
the correct sales tax
collected.
If you collect state and
local sales taxes imposed on
you as the seller of goods
or services from the buyer,
you must include the amount
collected in gross receipts.
If you are required to
collect state and local
taxes imposed on the buyer
and turn them over to state
or local governments, you
generally do not include
these amounts in income.
Inventory
at beginning of year.
Compare this figure with
last year's ending
inventory. The two amounts
should usually be the same.
Purchases.
If you take any inventory
items for your personal use
(use them yourself, provide
them to your family, or give
them as personal gifts,
etc.) be sure to remove them
from the cost of goods sold.
For details on how to adjust
cost of goods sold, see
Merchandise withdrawn from
sale in chapter
6.
Inventory
at end of year. Check
to make sure your procedures
for taking inventory are
adequate. These procedures
should ensure all items have
been included in inventory
and proper pricing
techniques have been used.
Use inventory forms and
adding machine tapes as the
only evidence for your
inventory. Inventory forms
are available at office
supply stores. These forms
have columns for recording
the description, quantity,
unit price, and value of
each inventory item. Each
page has space to record who
made the physical count, who
priced the items, who made
the extensions, and who
proofread the calculations.
These forms will help
satisfy you that the total
inventory is accurate. They
will also provide you with a
permanent record to support
its validity.
Inventories are discussed
in chapter 2.
Testing Gross Profit
Accuracy
If you are in a retail or
wholesale business, you can
check the accuracy of your gross
profit figure. First, divide
gross profit by net receipts.
The resulting percentage
measures the average spread
between the merchandise cost of
goods sold and the selling
price.
Next, compare this percentage
to your markup policy. Little or
no difference between these two
percentages shows that your
gross profit figure is accurate.
A large difference between these
percentages may show that you
did not accurately figure sales,
purchases, inventory, or other
items of cost. You should
determine the reason for the
difference.
Example. Joe Able
operates a retail business.
On the average, he marks up
his merchandise so that he
will realize a gross profit
of 33⅓% on its sales. The
net receipts (gross receipts
minus returns and
allowances) shown on his
income statement is
$300,000. His cost of goods
sold is $200,000. This
results in a gross profit of
$100,000 ($300,000 -
$200,000). To test the
accuracy of this year's
results, Joe divides gross
profit ($100,000) by net
receipts ($300,000). The
resulting 33⅓% confirms his
markup percentage of 33⅓%.
Additions to Gross
Profit
If your business has income
from a source other than its
regular business operations,
enter the income on line 6 of
Schedule C and add it to gross
profit. The result is gross
business income. If you use
Schedule C-EZ, include the
income on line 1 of the
schedule. Some examples include
income from an interest-bearing
checking account, income from
scrap sales, and amounts
recovered from bad debts.
