Gross Profit x Net Profit: What's the difference? (2023)

Gross Profit x Net Profit: An Overview

Two crucial profitability metrics for any business are gross profit and net profit. Gross profit represents sales or profit remaining after deducting cost of production from sales. Revenue is the amount of revenue generated by selling a business's goods and services. Gross profit helps investors determine how much profit a company makes from producing and selling its goods and services. Gross profit is sometimes referred to as gross income.

Net income is the profit left over from income after deducting all expenses and expenses. Net income, also known as net income, helps investors determine a company's overall profitability, which reflects how effectively the company has been managed.

Understanding the differences between gross profit and net profit can help investors determine whether a company is making a profit and, if not, where it is losing money.

gross profit

Gross profit, operating profit and net profit refer to a company's profits. However, each represents revenue at different stages of the production and earning process.

Gross profit is the profit a company earns after deducting the costs of producing and selling its products.cost of goods sold(TEETH). Gross profit reflects how efficiently a company manages its production costs, such as labor and supplies, to generate revenue from the sale of its goods and services. A company's gross profit is calculated by subtracting the cost of goods sold for the companypayment periodyour total income.

revenue

Revenue is the total amount earned from sales during a specific period, for example. B. a quarter is reached. Sales are sometimes reported as net sales as they may include discounts and deductions for returned or damaged merchandise. For example, companies in the retail industry often report net sales as sales. Goods returned by your customers are deducted from your sales total. Sales are often referred to as the "top line" number because they are at the topproof of income.

Cost of Goods Sold (COGS)

The cost of goods sold refers to the direct costs involved in producing a company's goods. The CPV usually includes the following:

• Direct materials such as raw materials and inventory.
• Direct labor, such as wages for production workers.
• Cost of equipment used in production
• Equipment repair costs.
• factory utilities
• Shipping

We can see from the COGS items listed above that gross profit mainly includesvariable costs– or costs that fluctuate depending on production. Gross profit generally does not includefixed costs, are the costs incurred independently of production. Some fixed costs include wages (but not wages), rent, utilities, and insurance.

However, some companies may allocate part of their fixed costs used in production and report them per unit produced, calledabsorption costs. Suppose a factory produces 5,000 cars in a quarter and the company pays $15,000 in rent for the building. In the absorption calculation, each car produced would cost $3.

How to calculate gross profit

Gross profit is calculated by subtracting the cost of goods sold from a company's net sales or revenues, as shown below:

net income

net profit issynonym for profit of a companyfor the billing period. In other words, net income includes all costs and expenses incurred by a business that are deducted from earnings. Net income is often referred to as "thatfinal resultdue to its position at the bottom of the income statement.

While many items may appear on a company's income statement, depending on the company's line of business, net income is generally determined by subtracting the following expenses from revenue:

• operational expenses
• Interest on debts and loans
• Overhead bzwSales, general and administrative expenses(General and administrative costs)
• income tax
• depreciation, ie H. the allocation of fixed asset costs, eg. B. the equipment, under itslifespanor life expectancy

Net income also includes additional sources of income. For example, companies often invest their money in short-term investments, which are considered a form of income. Likewise, proceeds from asset sales count as income.

How to calculate net profit

As mentioned above, net income is the result of subtracting all expenses and costs from revenue and adding revenue from other sources at the same time. Depending on the industry, a business can have multiple sources of income, in addition to income and various types of expenses. Some of these sources of income or expenses may be presented as separate items on the income statement.

For example, a company in the manufacturing sector would likely have CPV listed. On the other hand, a service sector company would not have CPV; Instead, its costs could be included in operating expenses.

The general formula for net income can be expressed as follows:

• net income= Total Revenue - Total Expense

A more detailed formula could be expressed as follows:

• net income= Gross Profit - Operating Expenses - Other Operating Expenses - Taxes - Debt Interest + Other Revenues

net income example

Suppose a company has sales of $1 million and has the following costs and other income:

• Cost of Goods Sold of $600,000
• Operating expenses of $200,000
• $10,000 in debt payments
• $5,000 tax payments
• Interest income of $8,000

Net income would be $193,000 ($1,000,000 - $600,000 - $200,000 - $10,000 - $5,000 + $8,000).

main differences

Gross profit assesses a company's ability to generate profits while controlling its production and labor costs. As such, it is an important metric for determining why a company's profits are increasing or decreasing by looking at sales, production costs, labor costs and productivity. If a company reports an increase in sales, but this is more than offset by an increase in production costs, such as labor costs, gross profit will be lower for that period.

For example, if a company does not hire enough production workers for the peak season, it would generate more overtime for existing workers. The result would be higher labor costs and an erosion of gross profitability. However, using gross profit as a measure of overall profitability would be incomplete as it does not include all other costs associated with operating the business.

Net income, on the other hand, represents the income from all aspects of a company's operations. As a result, net income is broader than gross income and can provide insight into the effectiveness of the management team.

For example, a company could increase its gross profit if it borrowed a lot of money. the extrainterest expensePaying off more debt could hurt bottom line despite the company's successful sales and production efforts.

Gross Profit and Net Profit Restrictions

Gross profit is not a very useful metric by itself. Net income is much more useful in determining a company's financial condition. But net income is also limited in the sense that it is only useful for evaluating a company's performance from year to year.

Also, comparing the net income of two different companies doesn't say much, even if they are in the same industry. It simply tells you which company generated the most revenue based on how that company allocates its expenses.

Net income can be misleading—non-cash expensesare not included in your calculation. If these are deducted, the net profit can be drastically reduced.

Operating Profit, Gross Profit and Net Profit

It's important to note that gross profit and net profit are just two of the profitability metrics available to determine a company's performance. For example,operational resultis a firm's earnings before interest andLeadbe deducted from the so-called earnings before interest and taxes (EBIT).

However, when calculating operating profit, the company's operating expenses are subtracted from the gross profit. Operating costs includedgeneral costsCosts such as salaries, leave costs or administrative activities. Asgross profit, operating profitmeasures profitability by taking part or part of a company's income statement, while net income includes all components of the income statement.

Gross profit vs net profit users

In many cases, the main difference between gross profit and net profit lies in the different groups of users and their intentions with the information.

Entrepreneur/CEO

Business owners and managers use gross profit information to assess the profitability of their main business operations. While business owners use net income, selected department heads are particularly interested in how selling and manufacturing the actual product is done without regard to administrative costs.

investors

Net income is a key metric that investors use to assess a company's profitability and growth potential. If a company does not have positive net income, investors may not be interested. Even if a company has positive gross income, investors are primarily interested in knowing what net income it is generating and what possible future dividend payments (from net income, not gross income) might flow back to them.

creditors and banks

creditors andFinancial InstitutionUse net income information to assess a company's creditworthiness and make credit decisions. As a result, banks often require a company to provide an income statement (and often a multi-year income statement) before granting a loan. While the bank may underwrite on a gross profit basis for major product lines, banks are more interested in seeing net cash flow after all costs (especially interest).

tax authorities

Governments do not tax gross profits. Federal, state, and local taxes are usually calculated after accounting for all expenses. While certain tax credits or deductions may be closely related to gross profit, government agencies are most interested in a company's net income when assessing taxes.

Examples of gross profit versus net profit

In most cases, companies report gross profit and net profit as part of their externally published financial statements. Consider the following image, which shows Best Buy's income statements for tax years ending in 2020, 2021, and 2022.

For fiscal 2022, the company posted net sales of $51.7 billion and cost of sales (cost of sales) of $40.1 billion. Therefore, as reported in its financial statements, the company had a gross profit of $11,640 million.

If you look further down the financial statements, it's a far cry from the $2.4 billion in net income the company reports. While most of this difference is due to selling, general and administrative (SG&A) expenses, Best Buy also paid $574 million in income taxes.

In another example, Macy's reported all required components as part of its third quarter 2022 reporting for the period ended October 29, 2022. However, the Company's consolidated income statement does not specifically report gross profit. Analysts will have to calculate for themselves what the difference will be between total sales ($5.23 billion + $0.2 billion) and manufacturing costs ($3.2 billion).

As seen on Best Buy, Macy's gross profit of more than $2.2 billion differs dramatically from its net profit. Macy's net income for the period was just $108 million as a result of sales, general and administrative expenses, liquidation expenses, interest expenses, impairment and restructuring expenses and income taxes.

the end result

Gross profit, or gross revenue, is an important profitability metric because it shows how much profit is left from sales after deducting the cost of production. Gross profit shows the efficiency of a company in generating profit from the production of its goods and services.

Net income, on the other hand, represents the income or profit left over after all expenses have been subtracted from income. It also includes other sources of income, such as B. Proceeds from the sale of an asset. Both gross profit and net profit are important, but they show a company's profitability at different stages.

While net income is considered the gold standard for profitability, some investors use other metrics, such as B. Earnings before interest and taxes (EBIT). EBIT is important because it reflects a company's profitability without borrowing costs or taxes that would normally be included in net income.