Gross Profit Vs. Net Profit: Learn The Major Differences
In terms of finances, profit is the ultimate goal of any business. To ensure company operations reach this target, finance experts and accountants pay close attention to cash flow and other business statistics.
Comparing earnings from former accounting periods shows how much your business has grown over time. These are crucial figures to calculate and must be handled with care to ensure they delivered the desired outcomes.
Keep reading to learn the difference between gross profit and net profit.
What Are Gross Earnings?
This figure refers to the incoming revenue from which the cost of goods sold (COGS) is subtracted. COGS include all expenses that go into manufacturing finished items that are eventually sold.
When people compare profit vs. gross profit, they essentially contrast overall revenue with the amount of money left after COGS has been deducted.
What Are Net Earnings?
This financial metric is calculated by subtracting all direct and indirect operating expenses from the incoming revenue. When people chart their profit vs. net profit, they essentially compare the overall funds earned to what they’re left with after COGS and other expenses are subtracted.
Income Statement
Gross profit and net profit will each be separate entries on your company’s income statement. This recordkeeping document is a centralized graphic representation of your business’s statistics. Since it includes the incoming revenue, all types of earnings, and the costs of goods sold, it offers you a quick analysis of gross versus net profit.
A separate section states the costs of operation, tax expenses, and interests accumulated. Net earnings are displayed at the bottom of your income statement.
How To Calculate Your Gross Margin?
Gross profit is the difference between the costs of goods and total earnings. The formula for arriving at this figure is as follows:
- Gross Margin = Total Earnings - Cost of Good Sold
Here’s an example:
Let’s assume you made $10,000 in sales over one calendar year. The total value of COGS amounted to $4,000. This figure reflects the funds directly spent manufacturing the finished goods.
To calculate your financial gain, simply subtract 4,000 from 10,000. Your gross earnings, in this case, would be $6,000.
Using this amount, you can determine the net earnings, otherwise known as the bottom line for businesses. Using this final sum, you can choose the money needed for reinvestment and other business expenses, such as employee wages.
How To Calculate Your Net Margin?
You can determine this amount using the following formula.
- Net Take-Home Amount = Gross Profit - All Business Expenses
Your complete business expenses include everything from COGS to interests, taxes, and operating expenditures. The latter comprises employee wages, rent costs, and cost depreciation.
Here’s an example:
To clarify gross profit versus net profit, consider this example. Expanding upon the same figures from earlier, we arrive at gross earnings of $6,000 for one year. From this amount, you’ll now deduct the following expenses: $1,500 for employee salaries, $150 for utilities, $200 in cost depreciation, $100 in interest, and $800 in taxes.
A sum of all these expenses will become your total business cost: ($1,500 + $150 + $200 + $$100 + $800) = $2,750
Subtract this amount from your gross income to find the net amount: $6,000 - $2,750 = $3,250
Knowing The Difference Between Gross And Net Profit
Familiarity with these crucial metrics is customary if you’re planning on running a successful business. Your business’s financial strength is the single most vital indicator that investors will use to inform their decisions. Calculating only your gross income typically won’t be enough for these experts. Therefore, if you provide extensive net earnings, they’ll feel more secure to invest.
Moreover, your income statement isn’t complete without both the gross and net wages. If you confuse the two, you run a risk of either leading your customers and potential investors astray.
Making educated financial decisions depends on you having a clear understanding of your net revenue vs. gross profits. Knowing your business’s gross earnings allows you to devise ways to reduce COGS, while the income statement indicates where to cut extra expenses.
The Bottom Line
Now that you understand the difference between gross profit and net profit, you’re past the preliminary step in handling your company’s finances. These numbers are reflective of different business statistics. Accordingly, grasping the relevance of both metrics will help you take smart steps for long-term growth.
