What is the Difference Between Gross Profit and Net Profit: Example
Difference Between Gross Profit And Net Profit
Are you a business owner analyzing the profit your business is making? or perhaps you are an investor analyzing a particular business for investment, then you should have clarity on the difference between gross profit and net profit. This will help you avoid any ambiguity regarding the profits of a company.
In this article, we will look at the difference between gross profit and net profit. First, we will look at gross profit and how to calculate gross profit. Then we will look at net profit and how to calculate net profit. We will also look at gross profit and net profit examples. Then we will look at the difference between gross profit and net profit.
What Is Gross Profit?
Gross profit is the amount of money a company keeps after deducting all costs associated with creating and providing a product or service. You can calculate your gross profit by subtracting your cost of goods sold (COGS) from your total sales. The cost of goods sold includes the labour required, raw materials, and even taxes on the property. Include everything sold when calculating total sales for the fiscal year/quarter. Sales of tangible assets such as buildings and equipment are excluded while calculating the total sales.
Gross profit is among the most important indicators of a company's success. When analyzing a company's financial stability and performance over the past five years, credit reports often show a company's profit and loss. This shows how well a company uses its human capital, raw materials, and other resources.
Gross Profit Calculation
Gross Profit = Revenue – Cost of Goods Sold
Your overall sales-related income is your revenue. And your COGS represents the cost of producing your goods.
Gross Profit Example
Imagine that your company generated $10,000 in revenue during one accounting period and spent $3,000 on the total cost of goods sold. To calculate your gross profit, deduct $3,000 from $10,000 to arrive at $7,000.
Remember that your company's bottom line is not your gross profit. Your gross profit does not accurately reflect how much you must use to pay yourself as a business owner or to reinvest in your company. However, you may figure out your net profits using your gross profits.
What Is Net Profit?
Net profit refers to a company's earnings after deducting all operating expenses, interest, taxes, and cost of goods sold. A business's net profit is a net loss when the number is negative. To calculate net profit, you must know the company's gross profit.
Net profit is an important factor in evaluating a business's financial health. It indicates whether the company is profitable. Your net profit value can impact decisions about when and how to grow your business and when to cut costs.
Net Profit Calculation
A company's gross profit must be known to determine its net profit. The following is the formula for net profit:
Net Profit = Gross profit – Expenses
Net Profit Example
Let's assume that your company made a gross profit of $7,000 during an accounting period using the gross profit example from above. In addition, you have costs of $200 for utilities, $1,200 for rent, $3,000 for staff salaries, $400 for supplies, $400 for depreciation, $1,500 for taxes, and $200 for interest.
To start, add up your company's expenses ($1,200 + $200 + $3,000 + $400 + $400 + $1,500 + $200). You can now deduct $6,900 in total expenses from your $7,000 gross earnings. $6,900 is the total amount you spent. The net profit for your company is $100.
What Is The Difference Between Gross Profit And Net Profit
The key differences between gross profit and net profit are-
- A metric for assessing a company's effectiveness is gross profit. It computes the efficiency with which the business uses labour, supplies production, or offers customer service. Net profit is what determines a company's financial health. It shows whether the business makes more money than it spends.
- The advantage of calculating gross profit is that it allows us to control the company's excess costs. The advantage of calculating net profit is that it enables us to evaluate the company's performance.
- Since the gross profit does not account for all costs, including taxes, loan interest, and other expenses, it cannot be entirely relied upon to guide financial decisions. Conversely, you can base your decisions on the net profit and expand your company.
Limitations 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. Therefore, gross profit is not important to them.
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.
While gross profit is the amount left over after deducting the cost of items sold from revenue, net profit shows how much is left over after all allowed business expenditures have been paid. To get at net profit, you must first determine gross profit. You can create an income statement if you know the exact gross and net earning amounts. Accurate value calculation is crucial since gross and net profit are interdependent. This would enable you to preserve the data's accuracy and evaluate how well your business operates.