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H&r Block FreeH&r block free 7. H&r block free Figuring Gross Profit Table of Contents Introduction Items To Check Testing Gross Profit AccuracyExample. H&r block free Additions to Gross Profit Introduction 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. H&r block free You must determine gross profit before you can deduct any business expenses. H&r block free These expenses are discussed in chapter 8. H&r block free 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. H&r block free Businesses that sell products. H&r block free If you are filing Schedule C, figure your gross profit by first figuring your net receipts. H&r block free Figure net receipts (line 3) on Schedule C by subtracting any returns and allowances (line 2) from gross receipts (line 1). H&r block free Returns and allowances include cash or credit refunds you make to customers, rebates, and other allowances off the actual sales price. H&r block free Next, subtract the cost of goods sold (line 4) from net receipts (line 3). H&r block free The result is the gross profit from your business. H&r block free Businesses that sell services. H&r block free 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. H&r block free Your gross profit is the same as your net receipts (gross receipts minus any refunds, rebates, or other allowances). H&r block free Most professions and businesses that sell services rather than products can figure gross profit directly from net receipts in this way. H&r block free Illustration. H&r block free This illustration of the gross profit section of the income statement of a retail business shows how gross profit is figured. H&r block free Income Statement Year Ended December 31, 2013 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for this business is figured as follows: Inventory at beginning of year $37,845 Plus: Purchases $285,900 Minus: Items withdrawn for personal use 2,650 283,250 Goods available for sale $321,095 Minus: Inventory at end of year 32,955 Cost of goods sold $288,140 Items To Check Consider the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. H&r block free Gross receipts. H&r block free At the end of each business day, make sure your records balance with your actual cash and credit receipts for the day. H&r block free You may find it helpful to use cash registers to keep track of receipts. H&r block free You should also use a proper invoicing system and keep a separate bank account for your business. H&r block free Sales tax collected. H&r block free Check to make sure your records show the correct sales tax collected. H&r block free 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. H&r block free 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. H&r block free Inventory at beginning of year. H&r block free Compare this figure with last year's ending inventory. H&r block free The two amounts should usually be the same. H&r block free Purchases. H&r block free 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. H&r block free ) be sure to remove them from the cost of goods sold. H&r block free For details on how to adjust cost of goods sold, see Merchandise withdrawn from sale in chapter 6. H&r block free Inventory at end of year. H&r block free Check to make sure your procedures for taking inventory are adequate. H&r block free These procedures should ensure all items have been included in inventory and proper pricing techniques have been used. H&r block free Use inventory forms and adding machine tapes as the only evidence for your inventory. H&r block free Inventory forms are available at office supply stores. H&r block free These forms have columns for recording the description, quantity, unit price, and value of each inventory item. H&r block free Each page has space to record who made the physical count, who priced the items, who made the extensions, and who proofread the calculations. H&r block free These forms will help satisfy you that the total inventory is accurate. H&r block free They will also provide you with a permanent record to support its validity. H&r block free Inventories are discussed in chapter 2. H&r block free Testing Gross Profit Accuracy If you are in a retail or wholesale business, you can check the accuracy of your gross profit figure. H&r block free First, divide gross profit by net receipts. H&r block free The resulting percentage measures the average spread between the merchandise cost of goods sold and the selling price. H&r block free Next, compare this percentage to your markup policy. H&r block free Little or no difference between these two percentages shows that your gross profit figure is accurate. H&r block free A large difference between these percentages may show that you did not accurately figure sales, purchases, inventory, or other items of cost. H&r block free You should determine the reason for the difference. H&r block free Example. H&r block free Joe Able operates a retail business. H&r block free On the average, he marks up his merchandise so that he will realize a gross profit of 331/3% on its sales. H&r block free The net receipts (gross receipts minus returns and allowances) shown on his income statement is $300,000. H&r block free His cost of goods sold is $200,000. H&r block free This results in a gross profit of $100,000 ($300,000 − $200,000). H&r block free To test the accuracy of this year's results, Joe divides gross profit ($100,000) by net receipts ($300,000). H&r block free The resulting 331/3% confirms his markup percentage of 331/3%. H&r block free 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. H&r block free The result is gross business income. H&r block free If you use Schedule C-EZ, include the income on line 1 of the schedule. H&r block free Some examples include income from an interest-bearing checking account, income from scrap sales, income from certain fuel tax credits and refunds, and amounts recovered from bad debts. 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