Difference between gross profit and net profit - Zoho Books

Gross profit is the profit a business makes after subtracting all the costs that are related to manufacturing and selling its products or services. Books LearnMore Home / AccountingGrossProfitvsNetProfit–HowaretheydifferentGuides| 4minread |12comments ReadingTime:4minutesProfit isthemoneythat abusinessbringsin. Comparingcurrentprofitstoprofitsfrompreviousaccountingperiodshelpsyouunderstandthegrowthofthebusiness. Tocreateaccuratefinancialstatementsandmonitoryourbusiness’sfinancialhealth,youshouldunderstandthetwotypesofprofits:grossprofitandnetprofit. Whatisgrossprofit? Grossprofitistheprofitabusinessmakesaftersubtractingallthecoststhatarerelatedtomanufacturingandselling its productsorservices.Youcancalculategrossprofitbydeductingthecostofgoodssold(COGS)fromyourtotalsales. Whilecalculatingthetotalsales, includeallgoodssoldoverafinancialperiod,but exclude salesoffixedassetssuchas buildingsorequipment. Whatdoesgrossprofittellyou? Grossprofitisameasureof howefficiently anestablishmentuses laborandsuppliesformanufacturinggoodsorofferingservicestoclients.Itis animportantfigurewhencheckingtheprofitabilityandfinancialperformanceofabusiness. Grossprofithelpsyou understandthecostsneededtogeneraterevenue.Whenthevalueofthecostofgoodssold(COGS)increases,thegrossprofitvaluedecreases,soyouhavelessmoneytodealwith youroperatingexpenses. WhentheCOGSvaluedecreases, therewillbeanincreaseinprofit,meaningyouwillhave moremoneytospendforyourbusinessoperations. Whatisnetprofit? Netprofit istheamountofmoneyyourbusinessearnsafterdeductingalloperating,interest,andtax expensesoveragivenperiodoftime. Toarriveatthisvalue,youneedtoknowacompany’sgrossprofit. Ifthevalueofnetprofitisnegative,thenitiscallednetloss. Whatdoesnetprofittellyou? Netprofit is another importantparameterthatdeterminesthefinancialhealthofyourbusiness.It showswhetherthebusinesscanmakemorethanwhatitspends. Youcanuseyournetprofit to helpyoudecidewhenandhowtoworktowardsexpandingyourbusinessandwhentoreduceyourexpenses. Forabusinessowner,itisimportanttoknowthedifferencebetweenprofitandprofitability.Profitisanabsolutenumberwhichisequaltorevenueminusexpenses.Profitability,ontheotherhand,isarelativenumber(apercentage)whichisequaltotheratiobetweenprofitandrevenue. Profitabilityisameasureofefficiencyanditisusefulindeterminingthesuccessorfailureofabusiness. Netprofittellsyouabouttheprofitabilityofyourbusiness.Knowingaboutthesamehasseveraladvantages beneficial for thebusiness. Mostgovernmentformsandtaxformsrequireyoutodeclareyournetprofit. Basedonyournetprofit, the financialinstitutions,likebanks,decidewhethertoissue a loanornot. Thisstandstruebecausenetprofitisacommonfieldfoundonbusinesstaxforms. Furthermore,lendersandinvestorslookatyourcompany’snetprofittocheckifyou ownthecapabilitytopayyourfuturedebts. Importanceofknowingthedifferencebetweengrossprofitandnetprofit Netprofittellsyourcreditorsmoreaboutyourbusinesshealthandavailablecashthangrossprofitdoes.Wheninvestorswanttoinvestinyourcompany, they willrefertothenetprofitofyourbusinesstocheck whetheritisworth investing theirmoney. Understandinggrossprofittrends,ontheotherhand,canhelpyoufindwaystominimizethecostofgoodssoldorraise yourproductprices.Andifyourgrossprofitislessthanyournetprofit,thenyou knowthatyouneedtofindawaytocutdownyourexpenses. Youneedtoknowthecorrectvaluesofgrossandnetprofittogenerate anincomestatement:afinancialstatementthatreflectsthehealthofyourbusiness. Notknowingthedifferencebetweenthetwomay resultininaccuratefinancialdocumentsthat presentan unrealisticpictureofyourbusiness.The threemainfinancialdocumentsaidthemanagementinmakingimportantbusinessdecisions,soiftheyshowincorrectprofitinformation,itwillaffecttheirdecision-making. Howtocalculategrossandnetprofit? Youcancalculatebothgrossandnetprofitusing your incomestatement.Anincomestatementshowsyourcompany’stotalrevenueandcostofgoodssold,followedbytheoperatingexpenses,interestandtaxes. Inthefollowingexample,wearelookingatanannualincomestatement forExcelTechnologiesfortheyear2018.Thecompanyrecordsatotalrevenueof$200,000. Grossprofit=Totalrevenue–Costofgoodssold =$200,000–$50,000=$150,000 Successfulbusinesses showapositivevalue forgrossprofit.Themoneyaccountedasgrossprofit paysfor expenseslikeoverheadcostsandincometax. Tocalculatethenetprofit,youhavetoadd up alltheoperatingexpensesfirst.Thenyouadd the totaloperatingexpenses,including interestandtaxes,anddeductitfrom the grossprofit.Intheaboveexample,thetotaloperatingexpenses includingtaxesandinterest are$110,000. Netprofit=Grossprofit–Expenses =$150,000–$110,000=$40,000 Whenthevalueofnetprofitispositive,thenthebusinessownerscan pay themselvesandtheirpartnersafterpayingofftheirexpenses. Whenthevalueofnetprofitisnegative,thenitiscalledanetloss. Thisusuallyoccursin the caseofnewbusinessesthatdonotearnenoughtopayofftheiroverheadcostsorincometaxes.Insuchcases,keeptrackof eachtypeofexpensessothatyoucan findareasto cutdown withoutsacrificingthecompany’soperationsandefficiency.To avoidfacinganetlossaftertaxpayments,thecompanyshouldtrackexpensesbydevelopingabudgetthatincludespotentialtaxpaymentsperyear.Thiswillhelpthemdevelopsales goalsthatmeettheirfinancialneeds. Grossprofitvsnetprofit–Acomparisonchart Here’saquickreviewofthedifferencesbetweengrossandnetprofit : Yourtakeaway Netprofitreflectstheamountofmoneyyouareleftwithafterhavingpaidallyourallowablebusinessexpenses,whilegrossprofitistheamountofmoneyyouareleftwithafterdeductingthecostofgoodssoldfromrevenue. Youneedtocalculategrossprofittoarriveatnetprofit. Onceyouknow thecorrectvaluesof your grossandnetprofit,youcangenerate anincomestatement. Grossprofitandnetprofitareinter-dependent,socalculatingtherightvaluesisimportant.Thiswouldkeeptherecordsmaintainedandhelpindeterminingifyourbusinessisperformingefficiently. UsingZohoBooks,youcaneasilygeneratereal-timebusinessoverviewreportslikeP&Lstatementstoevaluatethevaluesofgrossandnetprofit.Tryoutourcloudaccountingsoftware forfreetoknowhowitwillhelpyougenerateandmaintainyourrecordswhileperformingbusinessactivitiesefficiently. RelatedPostsIncomestatement-Definition,ImportanceandExample «PreviousChapter3TipstoHelpYouOptimizeYourPutawayProcess NextChapter»CostSheet-Meaning,Example&Format VidhyaKrishnanContentMarketerforZohoBooks Cancelreply Δ ThissiteusesAkismettoreducespam.Learnhowyourcommentdataisprocessed. Reply Veryexcellentmostuseful👍😉 Reply Itwasveryclearandeasilyunderstandable!BIGAPPLAUSE👏🏻👏🏻🙌🏻🙌🏻👍🏻👍🏻 Reply Ithinkyoushouldhelpmioutwithsomeofmyaccountingquestions. Reply Heythere!Thanksforreachingouttous!Pleaseshareyourqueriestosupport@zohobooks.comformoreinformation. Reply It’sreallyveryinformative. Andclearedmyalldoubtsriseswhilestudying.👏👏😊😊 Greatexplaination Reply Excellent.Anyonecanunderstandirrespectiveoftheirbackground Reply thisisveryproductivetoread.ireallydoappreciatethebreak-down. Reply I’mveryhappytohavethiswonderfulexplanation Reply Quiteinformativeandwellexplained. Reply Thankyouthisiseducative Reply wellsimplified.Thanks. 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