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.
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:
Gross Profit = Business Revenue - Cost of Goods Sold
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:
Net Profit = Gross Profit - Business Expenses
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.
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:
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).
Net Profit= 800000 - 675000= 125000 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!