Question

Gross profit will result if: a. operating expenses are less than net income. b. sales revenues are greater than operating expenses. c. sales revenues are greater than cost of goods sold. d. operating expenses are greater than cost of goods sold.

Short answer

Gross profit results if sales revenues are greater than cost of goods sold (Option C).

Step-by-step solution

Define Gross Profit

Gross Profit is the financial metric used to assess a company's efficiency in using its resources to produce goods. It is calculated by subtracting the Cost of Goods Sold (COGS) from Sales Revenues. Mathematically, \( \text{Gross Profit} = \text{Sales Revenues} - \text{COGS} \).

Analyze Option A

Option A states that operating expenses are less than net income. Gross profit is not directly related to the comparison between operating expenses and net income. Therefore, this option does not describe how gross profit is calculated.

Analyze Option B

Option B suggests that sales revenues are greater than operating expenses. While gross profit relies on sales, the comparison is between sales revenues and COGS, not operating expenses. Hence, this option doesn't fit the definition of gross profit.

Analyze Option C

Option C indicates that sales revenues are greater than the cost of goods sold. This is precisely the definition of gross profit, where revenues exceeding COGS results in a positive gross profit.

Analyze Option D

Option D suggests operating expenses are greater than the cost of goods sold. Gross profit is not derived by comparing operating expenses and COGS, so this option doesn't define gross profit correctly.

Conclusion

Based on the definitions and analysis of each option, Option C is the correct answer because it aligns with the formula for calculating gross profit.

Key concepts

Cost of Goods Sold (COGS)

Cost of Goods Sold, often abbreviated as COGS, is a crucial component when understanding how a company calculates its gross profit.
Think of COGS as the direct costs associated with producing the goods that a company sells.
If you own a bakery, COGS will include the costs of ingredients like flour, sugar, and eggs, as well as the labor costs directly tied to making the bread.
COGS doesn’t cover indirect expenses like marketing or administrative costs. Calculating COGS simply involves adding up all these direct costs for the period you’re reviewing.
By knowing the COGS, businesses can determine their gross profit margin, guiding deeper insights into pricing strategies and overall efficiency.

• COGS affects pricing: The higher the COGS, the less profit made on each sale unless prices are adjusted higher.
• Efficiency indicator: Lower COGS can imply better management and production efficiency.

Understanding COGS is vital as it directly reduces sales revenue to arrive at gross profit.

Sales Revenues

Sales revenues are the total amount of money a company brings in from selling its products or services before any costs or expenses are deducted.
Often seen as the top line in an income statement, this figure is crucial as it showcases the company's ability to sell its goods or services. A higher sales revenue usually indicates a healthy business operation, but it’s not the sole measure of success.
Revenue must be balanced with other financial measures like COGS and operating expenses to determine the actual profitability.
For example, two companies might have similar sales revenues, but if one has a significantly higher COGS, its gross profit will be smaller.

• Top line indicator: Sales revenues reflect a company's market performance and demand for its products.
• Key to growth: Knowing this figure helps in planning expansions or understanding seasonal trends.

Analyzing sales revenue allows companies to develop strategies that boost profitability and ensure sustainable growth.

Financial Metric

Gross profit is a financial metric that captures the efficiency of a company's production and sales process.
This metric is key for assessing the profitability of a company's core business activities. To arrive at the gross profit figure, you subtract the Cost of Goods Sold (COGS) from Sales Revenues:\[\text{Gross Profit} = \text{Sales Revenues} - \text{COGS}\]This calculation delivers insights into how well a company manages its production costs relative to its revenues.A positive gross profit indicates that sales revenues exceed the costs of producing goods, suggesting efficient use of resources.

• Performance metric: Gross profit shows how well a company is producing and selling its core products.
• Indicator of effectiveness: High gross profit margins could suggest strong product demand or effective cost controls.

By examining gross profit, businesses can make informed decisions about pricing, production, and resource allocation.