Gross Profit vs. Net Profit (With Definitions and FAQ)

By Indeed Editorial Team

Published June 17, 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Companies can use various metrics to determine their profitability. One of them is profit, which refers to earnings from business activities within a period. If you work in finance or business, learning about the distinction between gross and net profit may be helpful to better understand the performance and financial position of an organization. In this article, we compare gross profit vs. net profit, define these concepts, and answer frequently asked questions about them.

Gross profit vs. net profit definitions

Before comparing gross profit vs. net profit, it's helpful to review the definitions of each:

What is gross profit?

Gross profit is a profitability metric that demonstrates the remaining income from a company's total revenue after deducting production costs. These costs often appear in the financial statement as COGS and represent the expenses that the company incurs to acquire or manufacture its products. While the items under COGS may vary depending on the nature of the business, they typically include variable costs, such as manufacturing overhead and the cost of materials and labour. These expenses typically change depending on the business output. To determine gross profit, companies often use this formula:

Gross profit = Revenue − COGS

Gross profit is important because it may help in evaluating a company's efficiency in cost management. Low production costs and high gross profit usually mean that the company can effectively manage costs, such as labour and materials, to generate income. Gross profit may not reflect the overall financial position of the organization because it doesn't account for other expenses. For example, if the company's debt and interest payments result in the depletion of its gross profit, then it's likely to experience a net loss.

What is net profit?

Net profit, which you can call net income or net earnings, is the key indicator of profitability for an organization. It refers to the revenue that remains after accounting for expenses, interest, and taxes. It also factors in other income streams that a company receives from its core operating activities. To compute net income, companies may use the basic formula which involves deducting their total expenses from total revenue. A more specific way of expressing this is:

Net income = Gross profit + Other income − (Operating expenses + Business expenses + Taxes + Debt interest expenses)

Net income is a crucial metric that can help in establishing the overall effectiveness of a company's management team. It can also demonstrate whether the business is generating enough profit to maintain or expand operations and increase stockholders' equity. The information that shareholders can glean from a company's net income can influence their investment decisions, which may affect the company's future growth. It can also help business owners and managers develop effective strategies for maximizing profit and achieving the company's goals.

Read more: What Is Net Income After Tax? (With Definition and Examples)

Comparing gross profit and net profit

Knowing the similarities and differences between gross profit vs. net profit can enable you to better understand an organization's performance. These figures can help you gauge the financial health of a company and determine if it achieved the desired level of profitability for a given period. Both of these can affect the decision-making of managers, executives, and stakeholders, especially about the future and direction of the business.

For example, the company's executives and management team may use the information they get from understanding this difference to decide if they can raise prices, buy new equipment, or expand their product line. If the figures are below their expectations, they may conduct an in-depth evaluation to determine which products or services are underperforming and which processes are taking up resources unnecessarily. This typically lets them pinpoint what they can adjust to improve the company's performance. Here are the similarities and differences between gross and net profit:

Similarities

Gross and net profit are both financial measures that can provide insights into the past performance and current state of a business. They're accounting concepts that represent a company's earnings, or the amount of money it made from its business operations and other income-generating activities. Accountants, managers, and stakeholders of an organization often use these to assess the overall health of a business. These may also be helpful when evaluating the company's strategies and making business decisions.

Related: Gross vs. Net Income (With Definitions and Differences)

Differences

Gross and net profit are distinct from each other in that they measure different parts of a company's revenue. Gross profit measures the difference between a company's sales and its cost of goods sold (COGS). Net profit represents the money a company makes after accounting for all expenses. Computing these requires different equations, with net income being a derivation of gross profit.

Another difference between these concepts is where they fall in the income or financial statement. While gross profit usually appears in the upper portion, beneath revenue and COGS, net income is typically at the bottom of the statement and represents the company's final earnings. In many cases, net income figures can be lower because they subtract expenses that aren't part of the calculation of gross profit.

FAQ about gross and net profit

While knowing the difference between gross and net profit is crucial, understanding ideas and terms relevant to these concepts may also help you evaluate the financial position of an organization more accurately. Here are answers to several common questions about gross profit, net income, and other important concepts:

Are profit and income the same?

Profit and income are generally similar in definition, which is why many people use them interchangeably. Both terms refer to the residual earnings a business generates within a specific timeframe after considering its revenue and expenses. Residual earnings typically represent the remaining amount from a company's operating revenue after deducting the cost of the capital it used to make money.

Profit and income can differ, especially when the source of income isn't the sale of goods or provision of services. For example, when a company earns interest income from their investments, they typically record this as part of their revenue rather than profit. Profit may also be distinct because it consists of subsets, such as gross or operating profit, which don't appear in the concept of income.

How does revenue differ from profit?

Revenue generally describes a company's earnings before deducting expenses. In the context of accounting and finance, this often refers to the gross sales of a business. Many people also call revenue the top line because it often appears in the first line of an organization's financial statement. Profit or income differ from revenue mainly because they refer to earnings after deducting the operating and nonoperating expenses of a business. When people use the term income, they usually mean net income.

How is operating profit distinct from gross profit?

While both terms represent the earnings of a business, they're distinct concepts. A company typically derives its operating profit from its gross profit. Operating profit refers to the residual earnings after deducting the cost of doing business. This cost encompasses all the expenses a company incurs in the production and sale of goods and services. To compute operating income or profit, companies generally use this formula:

Operating income = Gross profit − (Operating expenses + Depreciation and Amortization)

People often regard operating profit as synonymous with earnings before interest and taxes (EBIT). This is a measure of the operating efficiency of an organization and represents how much it makes from its primary business operations. These two terms differ in that EBIT takes into account nonoperating expenses and income. While there's a distinction, EBIT typically appears in the financial statements of many companies as operating profit.

Is net profit the same as net profit margin?

While these concepts differ, both are metrics that help in evaluating if a company's making enough profit from its business activities. Net profit margin measures net income as a percentage of the revenues a company receives. This typically makes it easier to assess an organization's current strategies for maximizing profit. It can also enable a company to forecast future income with revenue as the basis.

Related: How to Calculate Net Profit Margin (With Examples)

What is the relationship between net profit and cash flow?

Cash flow is a financial concept that describes how cash and cash equivalents transfer in and out of an organization depending on the transactions it makes. In general, companies strive for a positive cash flow to build confidence among shareholders. This can demonstrate their ability to cover expenses and obligations, return the shareholders' investment, and weather financial challenges.

People sometimes mistakenly assume that a high net income means a positive cash flow, and net loss results in negative cash flow. While this may often be the case, it's also possible for a company to sustain a net loss and still maintain a positive cash flow. An organization can also post a net profit and experience negative cash flow.

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