Difference Between Gross Profit and Net Profit
Profitability is an essential parameter to determine a company’s results and is used to assess and evaluate its performance and success. There are several ways to measure profitability. You need to calculate the amount of money coming in and going out by looking at two key parameters – gross profit and net profit. In this blog, we will cover the difference between gross profit and net profit.
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Comparison Table – Gross Profit vs Net Profit
The main difference between gross profit and net profit that that gross profit is the revenue received from a sale minus the cost of goods sold (COGS), while net profit is gross profit minus management expenses, interest, taxes, and depreciation.
| Aspect | Gross Profit | Net Profit |
|---|---|---|
| Definition | Revenue minus the cost of goods sold (COGS). | Gross profit minus operating expenses, taxes, and interest. |
| Scope | Concerned solely with the cost of producing goods. | Considers all operating expenses and financial obligations. |
| Calculation | Gross Profit = Revenue – Cost of goods sold | Net Profit = Gross Profit - Operating Expenses - Taxes - Interest |
| Purpose | Evaluates the profitability of core operations. | Measures overall profitability after all expenses. |
| Timing | Calculated before operating expenses and taxes. | Calculated after all expenses, taxes, and interest. |
| Indicator of Efficiency | Indicates how well a company manages production costs. | Reflects the company's ability to manage all expenses effectively. |
| Influence of Non-Operating Items | Excludes non-operating items like interest and taxes. | Includes non-operating items, such as interest and taxes. |
| Tax Calculation | It is not directly used for tax calculations. | Used as the basis for tax calculations in many jurisdictions. |
| Investor Focus | Often used to assess the operational efficiency of a business. | Of interest to investors as it shows overall profitability. |
| Risk Assessment | Provides a clearer view of the cost of producing goods. | Reflects the overall risk and performance of the company. |
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What is Gross Profit?
A company’s gross profit is the difference between total revenues and cost of goods sold (COGS). Revenue is the aggregate of money a firm earns in a given period.
Companies often list revenues as net sales, including discounts and refunds from returned goods.
Gross profit denotes a company’s profit before its expenses are deducted. It helps to determine a company’s efficiency using its raw materials, labour and production supplies. In other words, it is useful in emphasising the firm’s efficiency in production and pricing activities.
However, gross profit does not mean the expenditure of a company to pay off its shareholders or reinvest in the business. Nevertheless, it is crucial for accurately calculating the company’s net profits.
Gross Profit Calculation
To find a company’s gross profit, one must compute its earnings before deducting its expenses. The formula is expressed as –
Gross Profit = Revenue – Cost of Goods Sold
Let us understand the gross profit calculation using an example –
Company X earned Rs. 150,000 in a financial year, and its cost of goods sold amounted to Rs. 50,000. So, its gross profit would be –
Gross profit = Revenue – COGS
= Rs. (150,000 – 50,000)
= Rs. 100,000
What is Net Profit?
Net profit is the profit left after the COGS, operating expenses, interest, and tax are deducted from a company’s aggregate revenue. It is a Profit and Loss component, also known as a ‘bottom line’ given its position in financial or income statements.
Net profit also includes additional income like interest on investments and sales, wherein the operating expenses include –
- Rent
- Salary
- Utilities
- Depreciation
The net profit helps determine a company’s profitability and ability to convert sales into profits.
Net profit also helps business owners develop useful strategies and improve their financial standing and profitability. Similarly, it helps creditors to estimate the profitability of companies effectively.
Net Profit Calculation
To calculate a firm’s net profit, you must know its gross profit. The net profit formula is expressed as –
Net Profit = Gross profit – Expenses
The example below offers a clearer idea about the same.
Assume that Company X accrued a gross profit of Rs. 100,000 in a financial year and has accumulated expenses as follows –
| Expense Type | Amount (Rs.) |
| Rent | 30000 |
| Salary | 20000 |
| Taxes | 1000 |
| Utilities | 500 |
| Interest | 500 |
| Office Supplies | 400 |
| Depreciation cost | 350 |
| Total | 61750 |
Total expenses of the company = Rs. 61750 (sum of expenses)
Calculating the net profit –
Net Profit = Rs. (100,000 – 61750) = Rs. 38,250
If the net profit calculations give negative results, it will be called a net loss.
It is important to note that a company with a substantial gross profit can still incur a net loss based on its accumulated expenses. While gross profit is an important metric, it does not provide a complete picture of a company’s financial health. Net profit considers all expenses, more accurately representing a company’s profitability. Understanding these two metrics’ differences can help businesses better assess their performance and make informed decisions.
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FAQs
Why is gross profit important?
Gross profit is important because it shows how much money a business makes from its core business activities. It can be used to compare profitability between different products or services and to identify areas where costs can be reduced to increase profit margins.
Why is net profit important?
Net profit is important because it provides a comprehensive view of a company's financial health. It considers all expenses unrelated to producing goods or services, such as administrative and marketing costs.
How do gross profit and net profit differ in terms of their use?
Gross profit is primarily used to assess the profitability of a company's core business activities, while net profit is used to evaluate the company's overall financial performance.
Can a company have a high gross profit but a low net profit?
Yes, a company can have a high gross profit but a low net profit if it has high operating expenses, interest payments, or taxes. This means that even though the company is making a lot of money from its core business activities, it is also spending a lot on other expenses.
Can a company have a low gross profit but a high net profit?
Yes, a company can have a low gross profit but a high net profit if it has low operating expenses, interest payments, or taxes. This means that even though the company is making little money from its core business activities, it is also not spending much on other expenses.
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