Let’s face it! When it comes to calculating income and profit and taxes, we would rather still get paid in nuggets of gold and be able to exchange those for the essentials. But even so, people would find ways to complicate things, so we are better off understanding what we have than trying to run away from it. So let’s start with some basics, like what the difference is between gross profit and net profit.
Gross profit is also known as gross margin, sales profit or gross income and it represents the sum of money left from the revenue when all of the fluctuating costs have been deducted. These costs are the ones implied by the production of goods and do not include the fixed expenses with rent, payroll, insurance, advertising, etc. In accounting, gross profit is a required income statement entry and it reflects the core profitability of the firm. Profitable companies have a competitive advantage over their competitors, consisting either in a higher price for appreciated products and services or in lower operational costs.
Net profit is also referred to as bottom line, net income and net earnings and it represents the actual profit. It is the amount of sales income remaining after all operating expenses, interest, taxes and preferred stock dividends have been deducted. Net profit is the source of compensations of the stakeholders in a company and it is important to understand that it is not the amount of cash earned by a company in a given period of time. If a company cannot generate enough profit to compensate owners, the value of the shares will decrease considerably. Sales and consumer experience are responsible for fluctuations in net profit.
As confusing as accounting terms may be, it is important to understand what gross profit and net profit are and which of them illustrate a company’s profitability better. Gross profit only provides a general image of the company’s profitability as it shows how much of the money charged in a sale goes into production and how much remains with the company. The net profit is a more accurate measure as it represents the percentage of a company’s profitability per dollar of sales. It is the net profit that offers the company management a clear image of the expenses compared to the revenues.
The gross profit is a good way of understanding the operating costs better, whereas the net profit shows a company’s earnings per share, and it is the number of most interest for anyone with a stake in the company.
|Gross profit||Net profit|
|Is the calculated sum after the costs of producing goods have been deducted from the revenue||Is the calculated sum of the revenue minus all expenses|
|Not very conclusive to deciding a company’s profitability||Better for deducing a company’s profitability as it decides the value of earnings per share|