Gross Profit ND Net Profit

The terms "profit" and "income" are often used interchangeably in day-to-day life.
In corporate finance, however, these terms can have very different and specific
meanings, depending on the context in which they are used.
While income does mean positive flow of cash into a business, net income is
something much more complex. Profit is generally understood to refer to the
cash that is left over after accounting for expenses. Though both gross
profit and operating profit fit this definition in the simplest sense, the kinds of
income and expenses that are accounted for differ in important ways.
Perhaps the simplest way to understand these three concepts – gross profit,
operating profit and net income – and how they relate to each other is to look at
them in the order they appear on a company's income statement. The top line of
the income statement reflects a company's gross revenue, or the total amount of
income generated by the sale of goods or services. From there, various
expenses and alternate income streams are added and subtracted to arrive at
different levels of profit.
What Is Gross Profit?
Gross profit is the total revenue less only those expenses directly related to the
production of goods for sale, called the cost of goods sold (COGS). These
include expenses for raw materials and the labor to build or assemble a product
but exclude other wages and overhead expenses, such as rent.
Gross profit = Revenue - Cost of Goods Sold
The result is a profit metric that reflects the amount of money left over to fund the
business after accounting for the cost of simply producing a product. While gross
profit is technically a net measurement of profit, it is referred to as gross because
it does not take debts, taxes, interest or operating expenses into account.
What Is Operating Profit?
Next on the income statement is operating profit. Derived from gross profit,
operating profit reflects the residual income that remains after accounting for all
the costs of doing business. In addition to COGS, this includes fixed-
cost expenses such as rent and insurance, variable-cost expenses such as
shipping and freight, payroll and utilities, as well
as amortization and depreciation of assets. All the expenses that are necessary
to keep the business running must be included.
Operating Profit = Operating Revenue - COGS - Operating
Expenses - Depreciation and Amortization
However, like gross profit, operating profit does not account for the cost of
interest payments on debts, additional income from investments or taxes. Gross
profit reflects the profitability of a company's operations.
What Is Net Profit?
Finally, net income, also called net profit, is the infamous bottom line. This
reflects the total residual income that remains after accounting for all cash flows,
both positive and negative. From the operating profit figure is subtracted all debt
expenses such as loan interest, taxes and one-time entries for unusual expenses
such as lawsuits or equipment purchases. All additional income from secondary
operations or investments and one-time payments for things such as the sale of
assets are added.
The result is arguably the most important financial metric of them all, reflecting a
company's ability to generate profit for owners and shareholders alike.
Gross profit vs. net profit

Profit is the amount of money your business gains. The difference between gross
profit and net profit is when you subtract expenses.
Gross profit is your business’s revenue minus the cost of goods sold. Your cost of
goods sold (COGS) is how much money you spend directly making your
products. But, your business’s other expenses are not included in your COGS.
Gross profit is your company’s profit before subtracting expenses.
Net profit is your business’s revenue after subtracting all operating, interest, and
tax expenses, in addition to deducting your COGS. To calculate net profit, you
must know your company’s gross profit. Your business’s net profit is known as a
net loss if the number is negative.
Your business might have a high gross profit and a significantly lower net profit,
depending on how many expenses you have.
Gross and net profit on the income statement

Record both gross and net profit on your small business income statement. Your
income statement shows your revenue, followed by your cost of goods sold, and
your gross profit. The next section shows your operating, interest, and tax
expenses. The bottom line of the income statement is your net profit.
Here is a sample income statement, showing both your gross and net profits:
How to calculate gross vs. net profit

To find your gross profit, calculate your earnings before subtracting expenses. To
find your net profit, deduct all expenses from your incoming revenue.
Gross profit formula
Here is the formula for gross profit:
Gross Profit = Revenue – Cost of Goods Sold

Your revenue is the total amount you bring in from sales. Again, your COGS is
how much it costs to make your products.
Example
Let’s say your business brought in $12,000 in sales during one accounting period
and had a total cost of goods sold of $4,000. Subtract $4,000 from $12,000 to get
your gross profit of $8,000.
Remember that your gross profit is not your business’s bottom line. Your gross
profit does not represent how much you have to dip into for your business owner
wages or to reinvest in your business. But, you can use your gross profits to
calculate your net profits.
Net profit formula

Here is the formula for net profit:
Net Profit = Gross Profit – Expenses

Operating expenses, interest, and taxes make up your business’s total expenses.
Examples of operating expenses include costs like rent, depreciation, and
employee salaries.
Example
Using the above example for gross profits, let’s say your business has a gross
profit of $8,000 during an accounting period. You also have expenses of $1,000
for rent, $250 for utilities, $2,000 for employee wages, $300 for supplies, $500 in
depreciation, $1,000 in taxes, and $250 in interest.
First, total your business’s expenses. Your total expenses are $5,300 ($1,000 +
$250 + $2,000 + $300 + $500 + $1,000 + $250).
Now, you can subtract your total expenses of $5,300 from your gross profit of
$8,000. Your business has a net profit of $2,700.
Why knowing the difference between

gross and net profit matters
When you own a small business, you need to know your business’s gross and
net profits.
Investors and lenders want to know about the financial health of your business,
and showing them your gross profits just won’t cut it. You must know your
company’s net profits when seeking outside lenders. That way, investors and
lenders can determine how much money you have after paying all your
expenses.
To create your income statement, you need to be able to calculate both gross
and net profit. Confusing the two will only lead to muddled and inaccurate
documents.
You also need to know the difference between gross profit vs. net profit to make
educated business decisions. Knowing your business’s gross profit can help you
come up with ways to reduce your cost of goods sold or increase product prices.
And if your net profit is significantly lower than your gross profit, you can
determine expense cuts.
To calculate your business’s gross and net profits, you need organized and
accurate books. With Patriot’s online accounting software, you can track income
and expenses, allowing you to monitor your business’s financial health and
prepare financial statements. Start your free trial today!

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The terms "profit" and "income" are often used interchangeably in day-to-day life.

Gross profit vs. net profit

Gross and net profit on the income statement

How to calculate gross vs. net profit

Gross Profit = Revenue – Cost of Goods Sold

Net profit formula

Net Profit = Gross Profit – Expenses

Why knowing the difference between

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