Every successful business requires revenue and profits to keep them afloat and in operation. Without any gains or even income for that matter, sustainability is out of the question. Businesses, company’s or even start-ups have to have a keen eye on how much money is being made by the company and compare that to the expenses. Even comparing it to the previous year’s income could give profitability or loss-making scenario of the company.
In terms of calculating revenue, there are two major terms and formulas that every business must and should keep in mind. They are the Gross Profit Formula and Net Profit Formula. It’s a crucial factor that should allow an individual to keep track of the business’s financial accounts and overall health. For those willing to know more about these, we have explained them in detail below.
What is Gross Profit?
Gross Profit or GP is the profit that a company or business makes after eliminating costs incurred in the production or distribution of goods. These costs include production utilities, labour, shipping charges, equipment costs, raw material costs, repair expenses, and more.
However, Gross Profit doesn’t reflect on the total money it would spend on paying off its shareholders or other investors. The excess money would be the company’s profits and could be used for company-oriented operations. It’s significant as it tells anyone the financial well-being and profitability of the business.
Gross Profit Formula
Gross Profit = Total Sales – Total Cost of Goods Sold (COGS)
If the cost of goods sold increases, then gross profit decreases and vice Versa.
What is Net Profit?
Net Profit is the amount of excess money that a company generates after deducting taxes, rent, salaries, operating costs, and other expenses. It denotes how profitable the company is even after all the costs are subtracted from revenue. If the value of Net Profit is negative, then it is considered as a net loss.
Under Net Profit, things such as depreciation, rent, salaries, utility costs, interest, taxes, etc. are reduced from the gross profit. Anything and everything that the company has to pay for its operation comes under net profit calculation and is to be deducted from the revenue generated. Depending upon your Net Profit, companies can get to know how profitable they are in that fiscal year.
Net Profit Formula
Net Profit = Total Revenue – Total Expenses or
Net Profit = Gross Profit – Expenses
The money generated under Net Profit could be used to expand the business or anything else to help the company thrive and earn more. It’s an important term as banks usually give out loans seeing their net profit numbers. Even if you want to onboard any investor, then your Net Profit would decide the fate of your investment opportunities.
Gross Profit and Net Profit Examples
Let’s learn how to calculate Gross Profit and Net Profit:
To calculate Gross Profit, you will have to calculate the revenue generated minus the cost of goods sold.
GP = Revenue – COGS.
To have a better overview of the calculations of gross Profit, an example has been illustrated below.
Consider a company that earned Rs. 12,00,000 in a fiscal year and the Cost of goods sold was around Rs. 4,00,000. If you wanted to calculate the Gross Profit, then it would be as follows.
GP = 12,00,000 – 4,00,000 = 8,00,000.
Thus Rs. 8,00,000 is the Gross Profit of the company. However, if you wanted to calculate the gross profit ratio and gross profit margin, then the formula is as follows.
Gross Profit Ratio = (Gross Profit/Revenue) * 100.
Gross Profit Margin = Gross Profits/Revenue (or Net Sales)
For the calculation of Net Profit, you will have to find the Gross Profit. Taking the Gross Profit and eliminating the expenses from it will give you Net Profit.
For a better understanding, let’s discuss this with an example. A company XYZ Ltd. has generated a Gross Profit of Rs. 80,000. However, the expenses that it accumulated is given as follows.
Salary – Rs. 20,000
Rent – Rs. 10,000
Tax – Rs. 10,000
Interest – Rs. 2,500
Office supplies – Rs. 3,000
Depreciation cost – 5,000
Utilities – 2,500
Based on the above, the total expense comes up to Rs. 53,000 only. As per the formula denoted earlier the net profit calculation is given as follows:
Net profit = 80,000 – 53,000 = Rs. 27,000
However, if the figure comes negative, then the company has incurred a net loss. For the calculation of net profit ratio and net profit margin, the formulas are given as follows.
Net profit ratio = (Net Profit/Revenue) * 100.
Net profit margin = Net Profit/Revenue (Net Sales)
Gross Profit vs. Net Profit
Gross Profit and Net Profit are quite significant, given that they denote how much revenue has been generated and how profitable any respective company is in its operations and services. In fact, these are the foundation of calculating important financial ratios and review an organization’s performance.
Without the two crucial terminologies, knowing the growth ratio, the profit/loss generation factors, etc. wouldn’t come to light. It’s a simple way of analyzing the business and knowing where to cut down to ensure maximum profits and returns.