Let's start with a review of some terms.
Sales revenue is the amount earned from selling goods - it's a revenue account.
Sales returns and allowances is the amount of buyer returns or allowed deductions from invoice price. It is a contra-revenue account, which means it has a normal debit balance.
Sales discount is the reduction in the amount of cash received from a customer for early payment. It is a contra-revenue account and it also has a normal debit balance.
Net sales revenue is the amount a company has earned on sales of goods after returns, allowances and discounts have been deducted. It is not an account, but rather a subtotal.
Cost of Goods Sold is the cost of inventory sold to customers and is an expense account.
Gross profit is the dollar amount goods are sold for, greater than the cost of goods sold. Net sales less the cost of goods sold. It is not an account but rather a subtotal.
Since net sales revenue and gross profit are subtotals, we need to learn how to calculate both.
Net sales revenue is calculated as sales revenue minus sales returns and allowances minus sales discounts. It is the most important revenue figure because it is the most meaningful to investors and creditors.
Now that we know how to calculate net sales revenue, let's calculate Gross profit. Gross profit is net sales minus the cost of goods sold.
Gross margin percentage, which is sometimes called the gross profit percentage, is a ratio that shows how much of every sales dollars is going to gross profit. This is very helpful for investors and creditors when they compare companies of different sizes.
Gross margin percentage is calculated by taking the gross profit in dollars and dividing it by the net sales revenue in dollars.
Gross margin is one of the most carefully watched measures of profitability by internal and external use of the financial data. A small increase may signal an important rise
in income. Conversely, a small decrease may signal trouble.