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Gross Profit vs Net Profit: Gross profit focuses on core operational profitability, while net income considers overall profitability after all expenses. Both terms are crucial for assessing a company's financial health and overall profitability.

Other Types of Profit

  1. Operating Profit (Operating Income or Operating Earnings)
  2. Gross Profit Margin
  3. Net Profit Margin
  4. EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)
  5. Profit Before Tax (PBT)

What is Gross Profit?

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Gross profit meaning represents the revenue generated by a business minus the cost of goods sold (COGS). It is a key financial metric that reflects the profitability of a company's core operational activities.

By calculating gross profit, businesses can evaluate their efficiency in turning sales into profit and get a fundamental view of their overall profitability without factoring in additional expenses beyond the cost of goods sold.

What Is Net Profit?

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Often referred to as net income or net earnings, net profit meaning shows the amount of money a company has left after deducting all of its expenses from its total revenue. It indicates a company's overall profitability.

In simple terms, net profit is the final figure that remains after accounting for all the costs associated with running a business. It provides a comprehensive view of a company's financial performance, taking into account both its operational and financial activities.

Net profit is a crucial metric for investors, analysts, and business owners to assess the bottom-line profitability of a company.

Net Profit vs Gross Profit

Net profit and gross profit are both important financial terms that provide insights into a company's profitability, but they represent different stages in the income statement. Reflecting distinct aspects of a business's financial performance, let's explore their differences.

Expense Deductions

Source : investopedia

Gross Profit: In the context of gross profit, the primary expense deduction is the cost of goods sold (COGS). COGS represents the direct costs associated with producing or acquiring the goods sold by a business.

Net Profit: Net profit considers a broader range of expense deductions beyond COGS. This includes operating expenses (such as rent, salaries, and utilities), interest, taxes, and other costs associated with running the business.

Comprehensive vs. Specific

Gross profit and net profit offer distinct perspectives on a company's financial performance. When we consider the specific perspective of gross profit, the focus narrows down to the direct costs associated with the production or acquisition of the goods a company sells. 

On the other hand, net profit takes into account all costs associated with running a business. Beyond just the direct production costs (COGS), net profit considers operating expenses, interest, taxes, and any other financial elements impacting the bottom line.

Tax Considerations

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Gross Profit and Tax: Gross profit is the starting point to figure out taxable income. Taxes are usually based on the money a business makes, and gross profit helps determine the income that will be taxed. It's a key factor in calculating taxable income.

Net Profit and Tax: Being the final measure of a company's profitability, net profit serves as a crucial basis for calculating income taxes. Taxes are assessed on the net income after deducting all expenses, including operating expenses, interest, and taxes.

Level of Analysis

Gross Profit: The analysis is more focused on the efficiency of a company's core operational activities, particularly in the production or acquisition of goods. It is often used to evaluate the effectiveness of production strategies and pricing decisions.

Net Profit: It encompasses all expenses associated with running a business, including not only COGS but also operating expenses, interest, taxes, and other financial costs. This level of analysis is used to assess the overall profitability and sustainability of a business.

Investor Perspective

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For investors, assessing both gross profit and net profit is pivotal. Gross profit, revealing operational efficiency, shows core business profitability after deducting the cost of goods sold. A robust gross profit margin indicates effective cost management.

However, net profit, encompassing all expenses offers a holistic view of a company's financial health. Net profit and its margins, when looked at together, help investors get a clear picture of a company's overall profitability, risks, and potential for consistent growth.

Users of Gross Profit vs. Net Income

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The profit margins are used for different purposes and cater different meanings to different users. Based on the business and financial analysis realm here are some users of gross profit and net profit.

Users of Gross Profit:

  • Internal Management
  • Investors

Users of Net Income (Net Profit):

  • Investors and Shareholders
  • Creditors and Lenders
  • Tax Authorities
  • Analysts and Financial Advisors

How Is Gross Profit Calculated?

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Gross profit is calculated by subtracting the cost of goods sold (COGS) from total revenue. The formula for gross profit is:

Gross Profit=Total Revenue−Cost of Goods Sold (COGS)

The description of the components is mentioned below:

  • Total revenue: The total income generated from sales of goods or services is called total revenue. The income includes all the money received from the customer before deducting any expenses.
  • Cost of Goods Sold: The COGS represents all the direct costs associated with producing or purchasing the goods. It merges the cost of raw materials, labor, and manufacturing overheads.

Example

Suppose a company, ABC Electronics, sells smartphones. In a given year, ABC Electronics has a total revenue of $1,000,000 from smartphone sales. The cost of goods sold (COGS) for these smartphones is $600,000.

Using the formula:

Gross Profit=Total Revenue−COGS

or, Gross profit  = $1,000,000 - $600,000

or, Gross profit} = $400,000

Therefore, ABC Electronics has a gross profit of $400,000. It is the direct cost associated with producing or purchasing smartphones.

How Is Net Profit Calculated?

Source : investinganswers

If you want to calculate net profit then subtract all expenses including operating, interest, taxes, and other non-operating expenses from total revenue. Simply the formula is:

Net Profit=Total Revenue−Total Expenses

Defining the term used above:

  • Total Revenue: It total income generated from sales of goods or services. It includes all the money received from customers before deducting any expenses.
  • Total Expenses: This incorporates all costs associated with running the business, such as operating expenses (e.g., salaries, rent, utilities), interest on loans, taxes, and any other non-operating expenses.

For the more easy understanding, the above formula can further be explicated into: 

Net Profit=(Gross Profit−Operating Expenses)−Interest−Taxes−Other Non-operating Expenses

Example:

Continuing the same example of gross profit, ABC Electronics had a gross profit of $400,000 from smartphone sales. Now, let's consider additional expenses:

  • Operating Expenses (e.g., salaries, rent, utilities): $150,000
  • Interest on Loans: $20,000
  • Taxes: $30,000
  • Other Non-operating Expenses: $10,000

Using the formula:

Net Profit=(Gross Profit−Operating Expenses)−Interest−Taxes−Other Non-operating Expenses

or, Net Profit = ($400,000 - $150,000) - $20,000 - $30,000 - $10,000

or, Net Profit = $200,000

Thus, ABC Electronics has a net profit of $200,000. It indicates the total money a company has left with after covering all costs and obligations.

Limitations of Gross Profit and Net Income

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While both gross profit and net profit can be important for your company, they have their limitations. Some of the key limitations associated with them include:

Limitations of Gross Profit:

  • It excludes operating expenses, giving an incomplete view of a company's profitability by focusing only on direct costs.
  • Interpretation of gross profit margins is limited by industry variations.
  • Overlooking non-operating items like interest and taxes, it potentially leads to an inadequate assessment of a financial health.

Limitations of Net Income:

  • Non-cash expenses are excluded from net profit.
  • It is vulnerable to one-time events, making it sensitive to unusual gains or losses that may distort the overall financial picture.
  • Ignoring financing structure, net profit fails to directly consider a company's capital and debt structure

Is Net Income or Gross Income Higher?

Source : co

Looking at the example above, it is clear that gross profit is higher than net profit, as net income reflects the company's profitability after deducting all relevant expenses.

To summarize:

Total Revenue>Gross Income>Net Income

Or,

Net Income

Total revenue is the highest figure, followed by gross income (which subtracts only the cost of goods sold), and finally, net income (which subtracts all operating and non-operating expenses).