What is Gross Profit?
Gross profit is the amount a company makes after the deduction of the cost directly incurred from the production or purchase of the product from its sales. It demonstrates how much money the company is earning after its main business activities have been subtracted from the total revenue, such as making or selling goods but not including other costs such as rent, salaries or taxes. It’s like looking at how much money you make from selling lemonade after you’ve paid for lemons, sugar, and cups, but before considering other expenses like advertising or utilities.
The formula to calculate gross profit:
                     Gross Profit = Revenue − Cost of Goods Sold (COGS)
What is Net Profit?
Net profit is the money that a company has got after paying for all the expenses that are necessary to run the business. It presents a full picture of company profitability by taking into account all costs, including not only the direct costs of production or acquiring the goods but also indirect costs.
The formula to calculate net profit is:
                      Net Profit = Total Revenue − Total Expenses
Gross Profit Vs Net Profit
| Aspect | Gross Profit | Net Profit |
|---|---|---|
| Definition | The difference between revenue and COGS | The difference between total revenue and total expenses. |
| Calculation | Gross Profit = Revenue - Cost of Goods Sold | Net Profit = Total Revenue - Total Expenses |
| Scope | Focuses only on direct costs of production | Includes all expenses, including operating expenses, interest, taxes, and depreciation |
| Components | Includes revenue and COGS | Includes total revenue and all expenses |
| Importance | Measures profitability at the production level | Measures overall profitability after all expenses |
| Financial Health | Provides insight into the efficiency of production and pricing strategy | Reflects the overall financial health and performance of the company |
Example:
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Let’s say a company sells handmade crafts
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- Total revenue (sales): ₹100,000
- Cost of goods sold (COGS): ₹60,000
- Operating expenses (salaries, rent, utilities, etc.): ₹20,000
- Interest on loans: ₹5,000
- Taxes: ₹10,000
- Depreciation: ₹3,000
Using these numbers, we can calculate the gross profit and net profit:
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- Gross Profit: Gross Profit = Total Revenue – Cost of Goods Sold (COGS)
                                                     = ₹100,000 – ₹60,000
                                                     = ₹40,000
So, the company’s gross profit is ₹40,000.
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- Net Profit: Net Profit = Total Revenue – Total Expenses
                                          = ₹100,000 – (₹60,000 + ₹20,000 + ₹5,000 + ₹10,000 + ₹3,000)
                                          = ₹100,000 – ₹98,000
                                          = ₹2,000
So, the company’s net profit is ₹2,000.
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In this example, gross profit represents the amount of money the company earns from selling its crafts after deducting the direct costs of producing them (COGS). Net profit, on the other hand, reflects the company’s overall profitability after accounting for all expenses, including operating expenses, interest, taxes, and depreciation.
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FAQs
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Gross profit is calculated by deducting the cost of goods sold (COGS) from total revenue, while net profit is calculated by subtracting total expenses from the gross profit.
Understanding the difference helps in evaluating a company’s efficiency, cost management, and overall profitability, which is crucial for investors, creditors, and management.
A high gross profit may indicate that a company is selling its goods or services at a price significantly higher than the cost to produce them, which can be a sign of strong demand or effective cost control.
A negative net profit, known as a net loss, implies that the company’s expenses exceed its revenues, which can lead to cash flow issues and, in the long term, threaten the company’s survival.