In step 2 of the gross profit method, the estimated cost of goods sold are

The gross profit method of estimating inventory is a method of calculating the ending inventory of a business in the absence of a physical inventory count at the end of an accounting period.

It is similar to the retail inventory method, and is sometimes referred to as the gross margin method.

Gross Profit Method Process

The gross profit method involves the following for steps.

  1. Calculate the historical gross profit percentage
  2. Calculate the cost of goods available for sale
  3. Estimate the cost of goods sold
  4. Calculate the ending inventory

Gross Profit Method Example

By applying these four steps an estimate of the cost of the ending inventory can be arrived at as follows:

Calculate the Historical Gross Profit Percentage

The gross profit percentage, sometimes referred to as the gross margin, is calculated using the following formula.

Gross profit % = Gross profit / Revenue

For example, suppose the historical accounts of a business show revenue of 120,000 and a gross profit of 72,000, then the gross profit percentage is given as follows:

Gross profit % = Gross profit / Revenue
Gross profit % = 72,000 / 120,000
Gross profit % = 60%

Calculate the Cost of Goods Available for Sale

The cost of goods available for sale is the beginning inventory plus any goods purchased during the accounting period.

Goods available for sale = Beginning inventory + Purchases

For example, if the beginning inventory is 18,000, and the purchases during the period are 65,000, then the cost of goods available for sale is as follows:

Goods available for sale = Beginning inventory + Purchases
Goods available for sale = 18,000 + 65,000
Goods available for sale = 83,000

All the amounts used in this step are at cost.

Estimate the Cost of Goods Sold

The cost of goods sold can now be calculated by applying the gross profit percentage to the revenue for the period using the following formula:

Cost of goods sold = Revenue x (1 - Gross profit %)

In our example, suppose the revenue for the accounting period was 150,000, with an estimated 60% gross profit percentage, the cost of goods sold is estimated as follows:

Cost of goods sold = Revenue x (1 - Gross profit %)
Cost of goods sold = 150,000 x (1 - 60%)
Cost of goods sold = 60,000

Calculate the Ending Inventory at Cost

Finally, the ending inventory at cost can be estimated using the following formula:

Ending inventory = Cost of goods available for sale - Cost of goods sold

In our example, the ending inventory at cost is calculated as follows:

Ending inventory = Cost of goods available for sale - Cost of goods sold
Ending inventory = 83,000 - 60,000
Ending inventory = 23,000

The four steps used in the gross profit method are summarized in the table below.

Gross profit method example summary1. Calculate Historical Gross Profit %Revenue120,000Gross profit72,000Gross profit %60%2. Calculate Goods Available for SaleBeginning inventory18,000Purchases65,000Available for sale83,0003. Estimate Cost of Goods SoldRevenue150,000Gross profit %60%Cost of goods sold60,0004. Calculate Ending InventoryAvailable for sale83,000Cost of goods sold60,000Ending inventory23,000

Our gross profits method calculator is useful for estimating the ending inventory using the four steps described above.

Gross Profit Method Formula

Combining the four steps above results in the gross profit method formula which can be stated as follows:

In step 2 of the gross profit method, the estimated cost of goods sold are
In step 2 of the gross profit method, the estimated cost of goods sold are

Using the data from the previous example and the gross profit method formula, the ending inventory is calculated as follows:

Ending inventory = Beginning inventory + Purchases - Revenue x (1 - Gross profit %)
Ending inventory = 18,000 + 65,000 - 150,000 x (1 - 60%)
Ending inventory = 23,000

Despite its apparent accuracy, the method relies on an estimated gross margin percentage based on historical information and assumes it will be the same in the following accounting periods. Any significant shift in the type of ending inventory and its gross margin percentage will cause inaccuracies in the calculation. While suitable for monthly management accounts, the profit method is generally not appropriate for use in the year-end financial statements, when a full physical inventory count should be carried out.

Last modified November 19th, 2019 by Michael Brown

About the Author

Chartered accountant is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.

What are the steps to calculate gross profit?

What is the gross profit formula? The gross profit formula is: Gross Profit = Revenue – Cost of Goods Sold.

What is estimated cost of goods sold?

Cost of goods sold (COGS) is calculated by taking the value of inventory at the beginning of the period being studied, adding the cost of any new inventory purchased over the covered period, and subtracting the value of inventory held at the end of the period.

How ending inventory can be estimated using the gross profit method?

Multiply the gross profit percentage by sales to find the estimated cost of goods sold. Subtract the cost of goods available for sold from the cost of goods sold to get the ending inventory.