What is gross and net profit?

What is gross and net profit?

Business is all about profit, and the goal of any business owner is to make money. However, there are different types of profit and understanding the difference will help you run your business better.

What is gross profit?

Gross profit is the profit made after all costs related to manufacturing or selling a product/services are subtracted. While calculating the total sales, include all goods sold over a financial period. Exclude sales of fixed assets such as buildings or equipment, however.

It measures how efficiently an organisation uses workforce and supplies for manufacturing goods or providing services to clients. It’s an important figure when calculating the profitability and financial performance of an organisation.

Gross profit helps you understand the costs needed to generate revenue. When the value of the cost of goods sold increases, gross profit value decreases. This means you have less money to deal with your operating expenses.

When cost of goods sold decreases, there will be an increase in profit, meaning you will have more money to spend for business operations.

What is net profit?

Net profit is the amount of money your business earns after deducting all operating, interest and tax expenses over a given period of time. To arrive at this value, you need to know a company’s gross profit. If the value of net profit is negative, then it is called net loss.

This kind of profit is another huge indicator of a company’s financial health. It shows whether the business can make more money than it spends. You can use net profit figures to decide when and how to work towards expanding your business and when to reduce expenses.

Most legal and government forms require businesses to declare their net profit, such as HMRC. This is a huge factor for banks and other lenders to determine whether or not to loan money to your business. Investors look at a company’s net profit to check if it has the capability to pay future debts.

Why it matters

Understanding the difference between the two is hugely important as a business owner or director. Net profit reveals the amount you’re left with after expenses. Gross profit, on the other hand, reveals how much cost actually goes into providing a product or service. This date is crucial when planning and strategising future plans and, as mentioned above, when applying for loans and talking to investors.

Net profit tells your creditors more about your business health and available cash than gross does, but gross profit data can help you minimise expenses and assist you in cutting down expenses.

Both net profit and gross profit are important on your income statement and incorrect profit information can have huge consequences going forward for your business – so it’s important you know your net from your gross!

If you want to discuss how to improve your profits, contact us today.