What is the difference between Gross Profit and Net Profit ?

In this blog you will to get know about two Key Matrics of Profitability i.e. Gross Profit and Net Profit.

What is the difference between Gross Profit and Net Profit ?

The amount of money that a startup / business keeps after all costs is known as profit. We can determine the amount of profits a company has made by deducting its expenses from its revenue.

Any startup founder who wants to understand the profitability should routinely evaluate the financial or income records. To calculate a company's profit, you must be well-versed with the basic differences between gross profit and net profit.

Gross profit and net profit are terms used to describe the revenue that a company makes at different phases of its operations. Let us understand more about Gross Profit and Net Profit (GP and NP)

What is Gross Profit vs Net Profit? 💰

Gross Profit and Net Profit are the two most important metrics to track the profitability of the company.

Gross Profit:

After deducting the Cost of Goods Sold (also called as COGS), Gross Profit is the amount your company makes in a certain time frame. The cost of goods sold comprises the money spent on raw material, labour costs, etc. All sales throughout an accounting period are taken into consideration when assessing the overall sales.  

Net profit:

The amount earned by the company (Total Revenue) less the cost of goods sold (COGS) and other operating costs over a given time period is your net profit. The costs also cover taxes, interest, Office & Admin cost and selling-related costs in addition to operating costs. Because it is typically stated at the bottom of the income statement, Net profit is also referred to as the bottom line.

After subtracting all of the costs incurred during that particular period, the net profit is estimated. The list of costs subtracted to determine net profit is provided below.

  • Operating expenses
  • Interest on loan accounts
  • Overhead expenses include selling expenses, administrative expenses, and other general expenses.
  • Depreciation

What is Cost of Goods Sold (COGS)

The cost incurred in creating finished items is referred to as the cost of goods sold. Cost of goods consists of:

  • Raw materials
  • Wages for labour
  • Running cost of the equipment required in production 
  • Equipment maintenance cost
  • Production facilities utility 
  • Transportation costs

You'll see that none of the expenses in the list above are fixed. Costs that change based on the manufacturing output are known as variable costs, which affect gross profit. In general, variable costs, make up the majority of gross profit. Fixed costs are those that remain constant regardless of the level of production (For example Rent, salary, insurance, and other expenses fall under the heading of fixed costs)

What is Revenue?

The total money made from sales during a given time period is referred to as revenue. Because it takes into discounts given, deductions for returns or damaged goods, and other factors, revenue is often referred to as Net Sales.

For instance, the textile industry typically calculates revenue as net sales after deducting all returns and damaged goods. Because it is always stated at the top of the income statement, revenue is also referred to as the top line of the business.

Understanding Gross profit vs. Net profit is crucial for figuring out if a company is profitable or not. As a founder of CFO you must be aware of the gross and net profit as well as their respective ratios. Lack of understanding of the differences could result in erroneous financial statements, which would reflect poorly on the state of your company.

Let's examine the main distinctions between gross and net profit.

Differences between Gross profit and Net profit

Difference Between Gross Profit and Net Profit

How Gross Profit and Net Profit determined?

An income statement or Profit & Loss Statement is necessary in order to determine Gross profit and Net profit. A company's cost of goods sold, revenue, operational costs, loan interest, and taxes are all listed on the income / P&L statement. The income statement's upper side is where you may see gross profit. Just below total income and cost of products sold is this amount. The income statement's bottom side is where you may find net income. It is the outcome of all costs minus income.

A business's cost of goods sold is subtracted from net sales to determine gross profit. The formula for gross profit is:

Gross Profit = Net sales - Cost of Goods Sold

All costs and expenses are subtracted from the revenue to determine the net profit. Because some companies have additional sources of income in addition to the revenue generated by the business, the income from other sources is also added to the revenue before deductions. The income statement breaks down the sources of income and expenses separately. A company in the service sector, for example, wouldn't have any manufacturing costs; instead, all of its expenses would be operating costs.

The formula for net profit is:

Net Profit = Total Revenue - Total Expenses

The following is a more complex formula to determine net profit:

Net profit = Gross profit - Operating expenses - Other expenses -Taxes - Interest on loans

Why Tracking Gross Profit and Net profit is Important?

Gross Profit
  • Gross profit is a metric for gauging a company's effectiveness. It calculates how effectively the company is using Raw material, Labour, supplying production, or providing customer service
  • It is one of the important terms, when calculating business performance in terms of finances and profit
  • Calculating the costs necessary to produce income or revenue is made easier with the help of gross profit
  • Examining a company's gross profit, can help to determine why its profit is increasing or decreasing. This can be determined by looking at the expenses incurred during production, labour, and sales.

 However, you cannot determine the overall profitability with just gross profit, as all the expenses are not considered. 

Net Profit
  • The financial health of a business is determined by Net profit. It displays whether the company generates more revenue than it spends.
  • When deciding whether or not to expand the company at a given time and how to reduce costs, net profit is a crucial factor.
  • Net income reflects a company's overall earnings. As a result, when compared to gross profit, net income is more thorough and provides a better picture of the success of the business.

The drawback of Gross Profit and Net profit

There are drawbacks to gross profit as well as net profit. The drawback of gross profit is that not all sectors of the economy can utilize it. For example, a service-based company wouldn't have any cost of products sold or production expenses. As a result, gross profit is irrelevant. Although net profit is the most comprehensive indicator of a company's earnings, it has several restrictions. Net profit might be challenging to understand at times. For instance, if a company sold an asset, the revenue might increase net profit for that period. This profit runs the risk of being confused with business profitability.

Conclusion

Gross profit is the company's profit following the deduction of the cost of its sold goods. It analyses whether a company can turn a profit despite incurring costs. Net profit is the amount left over after all costs have been deducted from sales. It establishes the performance level at which the company operates. Both the gross and net profits are significant because they show the profitability of the company at various stages. While net profit accounts for all sources of income in the income statement, gross profit only takes into account a portion of a company's revenue. Determining whether a company is making a profit or loss requires knowledge of the distinctions between gross profit and net profit.

FAQ 🙋

Que - What is Gross Profit

Ans - Gross profit is the total of all income earned by an individual or a business in a given year

Que - What is difference between Gross Profit and Net Profit ?

Ans - Gross Profit is calculated after deducing Cost of goods Sold from revenue whereas, net profit is calculated by deducting all expenses from revenue, including non-operating expenses such as interest and taxes.

Que - What is Formula for Gross Profit

Ans - Total Revenue - Cost of Goods Sold

Que - What is Formula for Net Profit

Ans - Total Revenue - Cost of Goods Sold - All other Cost (Sales & Marketing, Admin, Office, Salary, Rent etc.)

About Jordensky 🚀

At Jordensky, we specialize in accounting, taxes, MIS, and CFO services for Startups and growing business and are focused on delivering an experience of unparalleled quality. When you work with Jordensky, you get a team of finance experts who take the finance work off your plate – ”so you can focus on your business.”