Understanding the Difference Between Gross Profit and Net Profit

A startup owner should always review his or her income statements regularly to know how his or her company is doing in terms of profits. Every business owner wants strong profits, but just wishing isn’t enough. You must clearly understand your profits and the difference between gross profit and net profit.

Although gross and net profits may look quite alike, they tell you a different story about your business. Knowledge of both can improve your business and even attract investors into your organization. In this blog, we will be understanding what is the difference between gross profit and net profit.

Gross Profit vs. Net Profit

Gross profit is the money left after subtracting production costs from revenue. Net income is what’s left after all expenses, like taxes, are taken out of revenue. Revenue is the total money made from selling a company’s products or services.

Both gross profit and net income are important measures of a company’s success. Gross profit shows how much a company earns from making and selling its goods. Net income, or net profit, shows how well the company is managed overall.

Knowing the difference between gross profit and net profit helps investors see if a company is making a profit and where it may be losing money.

Why is it important to Understand Gross Profit and Net Profit?

Gross profit is calculated before net profit. However, it is useful for more than just the calculation of net profit. Gross profit shows how well your company is performing in terms of cost of goods sold. It helps you track the impact of production costs such as manufacturing and labor on your profit before the addition of other expenses.

While gross profits precede net profits, the former can be used for purposes beyond the calculation of the latter. Gross profits give you a view of your company’s health with regard to the cost of goods sold. Thus, you can use gross profit for the monitoring of your bottom line with regard to such things as your company’s manufacturing and labor costs before factors such as administrative costs get mixed with it.

Gross profit reflects how much of what you are generating in revenues is consumed in terms of raw materials, labor, and facilities in general. This helps you identify your flaws with gross margins. For example, if your raw materials are consuming too much of your profit, then it’s probably time to change suppliers.

Whereas net profit is a good factor that helps you understand the overall health of your business and your cash flow, net profit will clearly give a better view of this. It comes in handy when attracting investors. Good gross profit is an important component but investors care more about net profit since it shows that non-operational costs are not consuming all the profit. A positive net profit attracts more investors.

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How to Find Gross Profit and Net Profit

Calculating your gross and net profits is very simple, especially if your records are well organized. To find both, ensure you have a complete list of your business expenses, such as:

Raw material invoice
The cost involved in packaging
Utility statements
Tools and machinery costs
Marketing expenses
Rent & Employee wages

This information is needed to calculate net and gross profit. So collect all the documents before calculating to make the process easy.

Calculate the cost of goods and services (COGS) before calculating gross profit and net profit. Below formula is used to calculate COGS:

COGS= Beginning inventory+purchases+ending inventory

Meaning of the terms used in the above formula:

Beginning inventory: The quantity of inventory that exists as of the end of the previous period
Purchases: cost of the goods purchased during the period under consideration.
Ending inventory: The number of stock that remained unsold over the reporting period

Gross Profit Formula

To find the gross profit use the formula below:

Gross profit = sales revenue- COGS

Net Profit Formula

Once you have found the gross profit now you can calculate the net profit:

Net profit= gross profit-total expenses

Now you have found your net profit, this will help you give investors a better understanding of your business. As known, knowledge is power in business. This net profit helps you make wise decisions regarding the operational cost and non-operational cost as well as the sales process.

What is the Difference Between Gross Profit and Net Profit

Below we have listed the difference between gross profit and net profit:

Comparison Basis	Gross profit	Net profit
Definition	Such profit that is arrived after deducting the cost of goods sold from revenue.	Such profit that is arrived after deducting all expenses, such as operating costs, taxes, and interests from revenue.
Formula	Revenue – Cost of Goods Sold (COGS).	Revenue – (COGS + Operating Expenses + Taxes + Interest).
Scope	Gross profit mainly focuses on the core business operations and production costs.	Net profit basically covers the entire financial picture, including operational and non-operational expenses.
Objective	Gross profit allows one to evaluate the efficiency of producing or service delivery.	Net profit allows one to find the overall profitability of the business.
Costs involved	Gross profit considers only the cost of producing goods or services	Net profit takes into consideration all the business costs, such as salaries, rent, taxes, and loans.
Use	Gross profit is used in evaluating pricing and the efficiency of production.	Net profit is used in evaluating the overall financial health and attracting investors.
Indicator	Gross profit indicates how a company is managing its production cost.	Net profit indicates how well a company is managing all the expenses.
Decisions making	Gross profit helps to make cost control and pricing decisions.	Net profit helps make general business strategy decisions and future investments.
Reporting	Gross profit is presented in the income statement before operating expenses.	Net profit emerges at the bottom of the income statement as the final figure.