Difference between Gross Profit and Net Profit
In this tutorial, we will cover all the aspects of Gross Profit and Net Profit including their definition, the formula for calculating the difference between Gross Profit and Net Profit, the formula to calculate gross vs. net profit, and why it is essential to know the difference between Gross Profit and Net Profit.
Profit is the financial reward (usually in the form of money) that businesses or businesspeople bring in. It allows a company to have a better idea of its growth, performance, and sales. Businesses would fall or experience a significant loss if they don’t generate profits.
Therefore, companies make accurate financial statements to inspect their financial status. They make this analysis based on two types of profits, i.e., the Gross Profit and the Net Profit.
Gross Profit VS Net Profit
In the below table, we have discussed some of the significant differences between Gross Profit and Net Profit.
| S. No. | Comparison Basis | Gross Profit | Net Profit |
|---|---|---|---|
| 1. | Definition | Gross profit is used to calculate the efficiency rate via any firm (small, medium, big, or MNCs) measures their labor and supplies cost to manufacture products or provide services to clients. | Net profit is the measure of money any business or corporates brings in after subtracting all operating costs, income taxes, and business interests over a specific time. But Net Profit is dependent on a company’s gross profit. |
| 2. | Objective | Gross profit determines the expenses required to generate the company’s revenue. | Net profit’s objective is to calculate the profitability of any business. |
| 3. | Credit Balance | The Gross profit represents the credit balance of the business account. | The Net Profit determines the credit balance of the profit and loss account. |
| 4. | Importance | It is a significant figure to compare the profitability and commercial performance of a company. It also helps to access reasonable costs and benefits in determining the prices of the goods. | It is important as it helps to find out the company’s financial growth in a year. If Net profit’s value is negative, the company is at a loss. |
| 6. | Formula Used | Gross Profit = Business Revenue – Cost of Goods Sold. | Net Profit = Gross Profit – Business Expenses. |
Formula to calculate Gross and Net profit
It is mandatory to calculate the Gross profit to reach Net profit figure. Once you have the values of the accurate figures of your gross and net profit, you can easily create your business’s income statement and determine whether your business is growing or not.
So, one must calculate the correct values else you may end up with misleading data and chaotic records.
To find your gross profit, calculate your income before deducting expenses. To calculate your net profit, subtract all business expenses from your generated revenue.
Formula for Gross Profit
The formula to calculate Gross Profit is given below:
Where,
- Business Revenue: It represents the money you earned by selling your goods.
- Cost of Goods Sold (COGS: It signifies how much costs are generated to manufacture the products.
Example
Let’s consider your business has made sales of 12,000,00 INR during a financial year and the total cost of the manufacturing of the sold goods was 4,000,00 INR.
Now, to calculate your Gross Profit, subtract 4,000,00 INR from 12,000,00 INR. Therefore, based on the above figures the Gross profit of your business would be 8,000,00 INR.
NOTE: The Gross profit is not your business’s crux. Your gross profit does not signify the business owner’s actual income, nor can you plan your reinvestment based on its figures. It is a profit number that helps you to find your Net Profits.
Net Profit formula
The formula to calculate Net Profit is given below:
Where,
- Gross Profit: It represents the business’s profit before deducting the expenses.
- Business Expenses: It is the total of all taxes, bills, employee wages, shipping charges, rent, depreciation, bonus, marketing, production cost, etc., involved in making up your business.
Case I: Net Profit > 0
When the Net profit is positive (or greater than 0) with a significant amount, the business holders can pay themselves, and their business is running in profits.
Case II: Net Profit < 0
When the net profit is negative (or less than zero), the business is at a loss. SMEs (Small and Medium Enterprises) or start-ups face loss issues.
In the beginning, new businesses do not earn enough to pay off their operating cost, income taxes, or other business expenses.
In such cases, it is advised to maintain a steady record of every expense to cut down the cost wherever possible without sacrificing the business’s productivity and efficiency.
Example
It would be a continuation of the above example where our Gross profits were 8,000,00 INR. Let’s say your operating expenses include:
- 50,000 INR for rent.
- 1,50,000 INR for convenience and transportation
- 3,000,00 INR for employee salaries.
- 50000 INR for stocks.
- 25000 INR depreciation amount.
- 1,00,000 INR company taxes.
First, we need to calculate the sum of our business’s expenses.
Total expenses = 675000 INR = (50,000 INR + 1,50,000 INR + 3,00,000 INR + 50,000 INR + 25,000 INR + 1,00,000 INR).
Next, we will deduct the total expenses (675000 INR) from gross profit (8,00,000 INR).
Hence, the Net Profit of the company after deducting all the expenses would be 125000 INR.
Why knowing the difference between gross profit and net profit is essential!
- Though knowing the difference between Gross and Net profit is required in large cooperates, it becomes essential in a small business or SMEs as it helps them maintain their business health.
- Moreover, Financiers and lenders only invest in your business after knowing your businesses’ financial profits, and your gross profits won’t decline. One must know the figures of their company’s net profits by pitching to investors or outside lenders. After validating the figures, the investors will decide whether they want to invest in your company or not.
- Almost every company needs to make their income statement and raise a financial statement, and one needs to find out both the Gross and the Net profit.
- One should also know the difference between gross and net profit to create business strategies, investment plans, determine the company’s growth, and eventually make educated business decisions.
- Business Gross profit also helps the business owners to create various plans following which they can increase the cost of goods. And if their Net profit is less than the gross profit, they should cut down their business expense or come out with plans to boost their sales.