Which is why we’ve created our profit modeling software: to help owners of small businesses find their way to greater profitability.
There are two ways to measure profitability: gross profit and net profit.
Understanding gross profit vs net profit is essential to make business decisions, create accurate financial statements, and monitor your business’s financial health.
Let’s look at which profit metric is most useful for small businesses, as well as the differences between the two.
What is Gross Profit?
Gross profit, also sometimes termed gross sales, is the money left over after deducting the cost of goods sold (COGS) from revenue. In other words, gross profit equals total revenue minus the cost to produce or acquire the products or services you sell.
How to Calculate Gross Profit?
To calculate your gross profit, start with your total revenue. Then, subtract the cost of goods sold, which includes raw materials costs, factory overhead, and manufacturing labor. Subtracting COGS from revenue will give you your company’s gross profit.
Your cost of goods sold is a business expense related to making your products or delivering your services. But, your business’s other expenses like sales labor costs are not included in your COGS.
Keep in mind that COGS includes the cost of materials, items purchased for resale, freight-in costs, factory labor costs, and parts used in production. COGS can also include storage costs and other expenses. If you use contractors, or outsource any part of the production process, those costs should be included in COGS as well.
If you find COGS calculations pesky, you might just appreciate our handy COGS calculator. We simplify the tracking and reporting of COGS, operating expenses, profitability, and all other metrics key to the success of your small business.
Not only that, Profit Frog allows you to perform financial modeling and forecasting by adjusting the different metrics of your business and examining how their variations would impact your bottom line in the future. This is known as scenario planning and it’s super powerful for putting you in the driver’s seat.
Gross Profit Formula
Here’s the formula used to calculate gross profit.
Gross Profit = Revenue – COGS
Revenue = Number of goods sold × Sales Price
COGS = cost to produce or acquire the products or services you sell.
For example, let’s say your business sold $50,000 worth of goods last year and it cost you $35,000 to produce or acquire those goods. Your gross profit would be $15,000.
Gross profit is sometimes referred to as “gross margin” because it’s represented as a percentage of total revenue.
To calculate gross margin, divide gross profit by total revenue.
From our previous example, that would be $15,000/$50,000, or 30%.
What is a Good Gross Profit Margin?
When it comes to gross profit margin ratios, there is no one-size-fits-all answer.
For a SaaS business, or financial institutions, a gross profit margin of 50% to 80% is healthy, whereas for an ecommerce brand—depending upon the niche—30% to 40% would be average. It all depends on the business model, the industry, and the size of the company.
Service sector firms typically have higher production costs than, say, a software company. Their gross profit margins tend to be proportionally lower.
Clothing retailers can have gross margins of anywhere from 3% to 13%, while some fast-food chains can reach gross margins of 40%. Ultimately, the key is to know your industry and how your company stands up against your competitors.
The gross profit margin is one measure used to measure a company’s financial health. A gross profit margin that is too low can indicate that a company is not pricing its products correctly, or that it is overspending on raw materials. A gross profit margin that is too high can indicate that a company is not taking full advantage of its economies of scale.
However, gross margin is not as effective as net profit margin for determining efficiency, profitability and the long-term viability of your business. This is why our profitability planning software focuses on helping you model your net profit under various hypothetical scenarios.
Net profit tells you more about how efficient and profitable your business is.
Want to try our profitability modeling software for small businesses?
What is Net Profit and How to Calculate It?
Net profit is the final profit figure reported on a company’s income statement and is also sometimes referred to as “net income” or “bottom line.”
Net profit is the amount of revenue left over after deducting all other expenses from gross profit. In other words, gross profit minus all non-COGS expenses.
Net profit is what’s left over after all business expenses have been paid: COGS, operating expenses (OPEX), and any other costs the business incurs.
Understanding COGS vs OPEX
Cost of goods sold are mostly variable. That is, they change based on the amount of product being made or sold, and are incurred as a direct result of creating or acquiring the product. COGS are direct costs that include materials, packaging, shipping, machinery, direct labor costs for manufacturing the product, and depreciation of equipment. COGS are costs associated directly with manufacturing and shipping a good, or with delivering a service.
Fixed costs fluctuate less over time than do COGS. Also known as operating expenses (OPEX), these include office expenses, administrative expenses, marketing, employee benefits, rent, and other overhead costs incurred in the course of normal business operations.
To calculate net profit, simply subtract all expenses (COGS plus operating expenses plus any interest or debt payments plus taxes) from total revenue. Or, if you’ve already calculated gross profit, simply subtract OPEX and any of that other stuff (taxes, interest, etc) from gross profit. Either way, you arrive at the same figure: the amount of money remaining in your business after all the bills are paid.
Net Profit Example and Formula
Net Profit = Gross Profit – Operating Expenses – Additional Expenses – Taxes – Debt Interest + Additional Income
For example, let’s say your business had total revenue of $100,000 and its COGS are $20,000 and OPEX are $30,000. If the company has $10,000 in debt payments and $5,000 in taxes, its net profit would be $35,000.
If you’d rather not agonize over OPEX vs COGS, gross profit vs net—just use Profit Frog. We make business financials intuitive and easy, and we allow you to forecast into the future across multiple scenarios. For small businesses, we’re the best scenario planning tool on the market.
Net Income vs Net Profit: What’s the Difference?
Net profit and net income are synonymous terms. Or, nearly synonymous: depending on who’s using them, there can be a modest difference in meaning.
Net income is the total revenue of a business minus the total expenses. (This is also the definition most commonly used for net profit.) Net income is reported on the bottom line of a company’s income statement.
Net profit, on the other hand, is a measure of a company’s profitability over a certain time period.
- Typically used to communicate with investors so they can assess your performance
- Refers to funds remaining for distribution to equity shareholders
- Used to calculate your company’s profitability and associated tax liabilities
- Contrasted with gross profit (revenue minus COGS)
For businesses without equity shareholders (the majority of American small businesses), net income and net profit mean the same thing.
What Is a Good Net Profit Margin?
A good net profit margin is one that leaves a company with enough money to cover its expenses and reinvest in the business—with money left over. The net profit margin is calculated by subtracting a company’s total expenses from its total revenue, then dividing by the total revenue.
You can track your net profit margin on your income statement or P&L (profit and loss statement—one of the three main financial statements that all business owners should be familiar with).
This number is typically expressed as a percentage. For example, a company with a net profit margin of 5% would have $5 in profit for every $100 in sales.
There are a number of factors that can affect a company’s net profit margin, such as the cost of goods sold, operating expenses, and taxes. In general, companies with lower costs and higher revenue will have a higher net profit margin.
However, there is no set rule for what is considered a “good” net profit margin. Different industries have different standards, and what may be acceptable for one company may not be acceptable for another.
For example, businesses in the retail industry typically have very low net profit margins (around 3-5%), while businesses in the tech industry often have much higher margins (20-30%).
Net profit margin is a popular metric that businesses use to assess their performance, and it’s the metric that Profit Frog emphasizes in our financial forecasting for small businesses.
Profit Frog can help you increase your net profit margin by modeling under what conditions your net profit margin will increase or decrease. Armed with this knowledge, you can craft a dynamic business plan and update it as conditions change.
With Profit Frog, you can input different variables and see how they impact your profit margin. This information can be helpful as you make strategic decisions for your business. Get started with your free Profit Frog trial today.
Revenue, Cost of Goods Sold, Gross Profit, and Net Profit on the Income Statement
The income statement is one of the most important financial statements for a business. It tells you how much revenue the business has generated, what the cost of goods sold is, and what the gross profit and net profit are.
The income statement can be prepared on a quarterly or annual basis. Businesses use the income statement to track their performance over time and to make strategic decisions about where to invest resources.
For example, a business might use the income statement to decide whether to invest in new products or expand into new markets.
Gross Profit and Net Profit Example
Let’s say Company XYZ has the following income statement for the month of January:
Cost of goods sold: $40,000
Gross profit: $60,000
Operating expenses: $30,000
Net profit: $30,000
The gross profit would be $100,000 – $40,000 = $60,000.
The net profit would be $100,000 – ($40,000 + $30,000) = $30,000.
Gross Profit vs Net Profit Comparison
Understanding profitability thoroughly requires a grasp of net and gross profit metrics.
The gross profit number gives you one snapshot of your company’s financial performance. An advantage of gross profit is that it helps reveal a company’s excess costs. This can be helpful in identifying areas where costs can be cut without affecting quality or quantity of production.
However, gross profit does not take into account other expenses, such as overhead costs. As a result, gross profit is not always an accurate measure of business performance.
Net profit, on the other hand, gives a more accurate picture of a company’s financial health. Because it includes all expenses, net profit is a more reliable snapshot than gross profit when it comes to making decisions for further development of the company.
That’s why we focus on net profitability as the ultimate metric when helping you model profits.
Another difference between gross profit and net profit has to do with your credit balance. The credit balance of a company’s trading account is equal to its gross profit. However, the credit balance of its profit and loss account will be lower if the company has any net losses.
Gross profit does not show the credit balance of the profit and loss account, while net profit does. Again, net profit is a more useful measure for making financial decisions.
You can use our scenario planning software to identify opportunities and challenges both with gross and net profit that could impact your business in the future. This can help you to make informed decisions about how to grow your business and protect your profits.
The Importance and Limitations of Gross Profit and Net Income
When considering a company’s financial health, gross profit and net profit (also called net income) are two of the most important measures to look at. However, it’s important to keep in mind that there are some limitations to these measures.
- Gross profit doesn’t apply to all companies equally—a services company, for example, wouldn’t have production costs in the same way a manufacturing company would.
- Net profit can be misleading if a company has one-time events that increase profits for a period. For example, if a company sold a building, the money from the sale would increase net income for that period.
Profitability is fundamental to the success and sustainability of any business because it measures how much revenue a company generates relative to its expenses.
So while gross profit and net income are both important measures of profitability, they should be considered in conjunction with other financial measures to get a complete picture of a company’s financial health.
Profit Frog’s profitability modeling software can help you assess which profitability models will work best for your business and help you understand and predict what is driving profit and why. That’s how you’ll make the necessary changes to become profitable.
Profit and Revenue FAQ
Here are some common questions we get about the differences between gross profit and net profit. If you have further questions, don’t hesitate to reach out.
Can net profit be higher than gross profit?
It’s rare but possible for a business to have a higher net profit than gross profit. This might happen if the business has low operating expenses and has significant interest income from its investments.
However, this type of situation is generally not sustainable in the long run because it would mean that a business is not reinvesting enough in itself to cover its costs of production. So while it is possible for net profit to be higher than gross profit in the short term, it’s not usually a good sign for the long-term health of your company.
How do you calculate net profit from gross profit?
The first step in calculating net profit is to determine gross profit. This is the total revenue from your business minus the cost of goods sold.
For example, if your business had $100,000 in revenue and $50,000 in costs of goods sold, your gross profit would be $50,000.
From there, you need to subtract operating expenses.
Let’s say your business had $10,000 in operating expenses.
In this case, your net profit would be $50,000 – $10,000 = $40,000.
What is Operating Profit?
Operating profit is another word for net profit, but specifically refers to revenue minus COGS and operating expenses, but before deducting tax expenses and interest payments.
What are nonoperating expenses?
Nonoperating expenses refers to the cost of goods sold (COGS). COGS are those expenses directly related to producing a good or delivering a service.