When you look into the business and financial accounts you come across these two types of profits. Net profit and Gross Profit. In this article, we are going to discuss What is Gross Profit? What is Net Profit? And What is the difference between them?
Business and Financial accounts are motivated towards knowing the Growth and position of the company. In which, Profit is the key indicator for the company’s position and growth. Because profit is the fuel for all the Business and in short of it, it becomes really hard for a business to survive.
Meaning of Gross Profit
Gross Profit is the profit which a business/company receives after deducting its expenses incurred to sell that product. A balance amount left after deducting the Cost of Goods Sold (COGS) is gross profit.
Cost of Goods Sold is a total of variable expenses that were incurred to produce and(or) sell the Goods. COGS includes variable expenses such as
- Raw Materials
- Wages to Labour (directly related to production)
- the commission given on sales
- Selling expenses
- Delivery and shipping charges
We can calculate Gross Profit with the following formula,
Gross Profit = Sales – Cost of Goods Sold
Example of Gross Profit.
Alpha Co. produces a pencil, to produce a pencil it requires wood, graphite powder, and some colour. The selling price of each pencil is ₹8 and each pencil takes ₹1 of wood ₹0.75 of Graphite powder and ₹0.50 of colour so the total raw material used is ₹2.25 and other expenses such as Direct labour, commission, and selling costs per unit sum up to ₹1.75 so here, the total cost of goods sold is ₹4.
So, the gross profit for Alpha Co. after selling 50,000 pencils in a month will be:-
Gross Profit = Total Sales (Revenue) – Cost of Goods Sold
Gross Profit = 4,00,000 – 2,00,000
Gross Profit = 2,00,000
Here we can say that Alpha Co. made a (Gross) profit of ₹2,00,000.
Meaning of Net Profit
Net Profit is the actual profit that the company earns after its sales. It can be understood as the real profit or the cash/money that the company can retain to itself or distribute among its shareholders.
Taxes paid to the government are also deducted from the revenue to get Net Profit.
Generally, Net profit is the one that is referred to as the “profit”, which is also called the “Bottom Line”. So, we can understand Net profit as the profit that helps In the growth and survival of a business.
Deductions from the total sales/revenue for getting the net profit are as follows:
- Fixed Costs – Amortization, Depreciation, Insurance, Interest Expenses, Property Taxes, Rent, Salaries, Utilities.
- Variables Costs – Raw Materials, Price Rate per labour, Production supplies, Billables staff wages, Commissions, Credit Card fees on sales, Freight and Shipping charges, Advertising.
- “Net Profit is the balance after deducting All operation expenses, Interest, Taxes and Non-Common stock dividends(Preferred Stock Dividends)”
Formula to calculate Net Profit is as follows,
Net Profit = Total Revenue – Total Expenses
Example of Net Profit
Alpha Co. from the previous example earned a gross profit in a month of ₹2,00,000. The monthly salaries of sales staff are ₹50,000, Interest of ₹15,000 was paid, ₹20,000 was paid for taxes, Rent of ₹18,000 was paid, utility bill of ₹23,000 was paid.
So, the net profit of Alpha Co. Will be
Net Profit = Total Revenue – Total Expenses
Net Profit = ₹4,00,000 – COGS – Total Expenses
Net Profit = ₹4,00,000 – ₹2,00,000 – ₹1,26,000
Net Profit = ₹74,000
So, the actual profit or the Net Profit of Alpha Co. for the month was ₹74,000/-
Difference Between Gross and Net Profit.
| Gross Profit | Net Profit |
|---|---|
| It is the Top Line profit | It is the bottom line profit |
| Only COGS is deducted from the Total Revenue | All expenses are deducted from the Total Revenue |
| Taxes Paid are not deducted from the total revenue | Taxes Paid are deducted from the total revenue |
| All the variable costs related to production and(or) selling are deducted. | All the variable, as well as fixed cost, are deducted. |
| It is used to identify the profit on sales. | It is used to identify the total profit made on total sales after deducting all the expenses. |
| It cannot be called as the actual profit. | It is called as the actual profit. |
| It is generally higher than Net Profit | It is lower than Gross Profit. |
| It may not be considered during investment decisions. | It is considered when making investment decisions. |
Conclusion
Both gross profit and net profit are the profits but new and less experienced businessmen are often misled by the Gross Profit and make mistakes. so it is necessary to carefully evaluate all the revenues and expenses and to also create reserves for future expenses. A businessman should make his selling and marketing decisions on his net profit and not gross profit. Often Gross profit of a company may be good due to fewer variable costs but high fixed costs can lead to loss and even after making a gross profit a businessman can face losses which are the net losses.