Every businessman would like to know the profit earned or loss incurred during an accounting year. This is worked out in two stages. In the first stage the gross profit or gross loss is worked out, and in the second stage the net profit or net loss is ascertained. The net profit net loss indicates the overall result of the business operations, whereas the gross profit/gross loss reveals the difference between the sales revenue and the cost of goods sold. If the amount of sales is higher than the cost of goods sold, the difference would indicate gross profit.

Suppose, a trader has purchased goods costing Rs. 50,000. He sold them for Rs. 75,000. The gross profit earned is Rs. 25,000, being the difference between the sales value (Rs. 75,000) and the co\t of the goods sold (Rs. 50,000). 

In other words, gross profit is the excess of sales value of the goods sold over their cost. However, if the sales value of the goods sold is less than their cost, the result is called gross loss. The purpose of working out gross profit/gross loss is to ascertain the profit or loss from trading operations alone. It indicates whether purchasing and selling of goods have proved to be profitable for the business or not. 

1. Cost of Goods Sold

As stated above, the gross profit or gross loss is calculated by comparing the cost of goods sold with the sales. Hence, it is necessary to understand how the cost of goods sold is worked out. Let us take the case of a trader. If all the goods purchased have been sold out, the cost of goods sold will be equal to the cost of goods purchased. But, normally all the goods bought in a particular period are not completely sold out by the end of that period.

Some goods may remain unsold known as closing stock. Hence. the cost of goods sold is usually arrived at by adjusting the cost of closing stock in the cost of goods purchased. For example, during 1986 a trader bought goods worth Rs. 2,50,000. At the end of 1986 he had a closing stock (unsold goods) for Rs. 50,000. The cost of goods sold will be worked out as under: