Gross Profit vs Net Profit

What's the Difference?

Understanding your business's financial health is key, but it's easy to get lost in complex jargon. Two of the most important terms you'll come across are gross profit and net profit. Although they sound alike, they offer very different insights into your company's performance.

So, what is the difference between gross profit and net profit? In simple terms, gross profit shows what you earn from selling your products, while net profit is the money you have left after paying all your business expenses.

Knowing how to calculate and use these figures is essential for making smart business decisions, from pricing your products to managing your spending. In this guide, we'll break down everything you need to know, including:

• What is gross profit?
• What is net profit?
• How do you calculate each figure?
• Why do both metrics matter for your business's long-term success?

What is Gross Profit?

Gross profit is the lifeblood of your business—it’s the money left after you subtract the direct costs of producing or delivering your products and services. These direct costs, known as the Cost of Goods Sold (COGS), include materials, labour, and manufacturing expenses. Simply put, gross profit is your earnings before factoring in additional business overheads like rent, utilities, or marketing.

Why does gross profit matter?

It’s a key measure of your business efficiency. A strong gross profit indicates that you’re pricing your products right and managing production costs effectively. It’s a sign that your business is on the right track and making the most of its resources.

Want to grow your business? Keep an eye on your gross profit—it offers critical insights into how well you balance pricing, costs, and profitability. A healthy gross profit means more room to invest, innovate, and expand.

What’s included in gross profit?

To calculate gross profit, you need to know your Cost of Goods Sold (COGS). So, what exactly is included in COGS? These are the direct costs tied to producing your goods or services.

Key costs included in gross profit calculations are:

• Raw materials: The cost of the core components needed to create your product.
• Direct labour: Wages for employees who are physically making the product or delivering the service.
• Shipping and freight: The costs to get raw materials to your facility.
• Sales commissions: Payments made to your sales team for selling the product.

It's crucial to understand what is not included. Gross profit doesn't account for indirect costs like rent, marketing expenses, administrative salaries, or taxes. Those are factored in later when calculating net profit.

What is Net Profit?

Net profit, often called the "bottom line," is the ultimate measure of your business's profitability. It’s the amount of money left over after all your expenses, both direct costs like Cost of Goods Sold (COGS) and indirect operating expenses, are subtracted from your total revenue.

Why does net profit matter? Because it shows the true financial health of your business. This is the cash you can use to reinvest in growth, pay dividends to shareholders, or save for future plans. Think of it as the clearest indicator of how successful your business really is.

When people ask, "How profitable is your business?" they’re almost always talking about net profit. Knowing this number not only helps you track your growth but also makes it easier to make smarter financial decisions

What's included in net profit?

Net profit gives you the complete picture of your business's financial health. To calculate it, you start with your gross profit and subtract all other operating costs.

So, what expenses are we talking about?

Net profit includes everything from the cost of keeping the lights on to the taxes you owe. Here’s a breakdown of what gets deducted from gross profit to find your net profit:

• Operating Expenses: These are the costs required to run your business, but they aren't directly tied to creating your product or service. Think of things like rent for your office, utility bills, marketing campaigns, and office supplies.
• Salaries and Wages: This includes payments to all non-production employees, such as your administrative, marketing, and management staff.
• Interest: Do you have any business loans or lines of credit? The interest you pay on that debt is subtracted here.
• Taxes: This covers all the taxes your business is required to pay, most notably Corporation Tax.
• Depreciation and Amortisation: Your business assets, like vehicles or machinery, lose value over time. This gradual loss of value is an expense known as depreciation (for tangible assets) or amortisation (for intangible assets like patents).

How to Calculate Gross Profit and Net Profit

Now that you understand the definitions, how do you calculate these figures? The formulas are straightforward.

Gross Profit Calculation

The formula for gross profit is:

Gross Profit = Total Revenue - Cost of Goods Sold (COGS)

For example, imagine your business has a total revenue of £100,000 for the year. The cost of raw materials, direct labour, and shipping added up to £40,000.

Your gross profit would be:
£100,000 (Revenue) - £40,000 (COGS) = £60,000 (Gross Profit)

Net Profit Calculation

To find your net profit, you start with your gross profit and subtract all other business expenses. The formula is:

Net Profit = Gross Profit - Total Operating Expenses

Alternatively, you can calculate it directly from revenue:

Net Profit = Total Revenue - Total Expenses (COGS + Operating Expenses)

Using the previous example, let's say your operating expenses (rent, salaries, marketing, taxes, etc.) for the year totalled £35,000.

Your net profit would be:
£60,000 (Gross Profit) - £35,000 (Operating Expenses) = £25,000 (Net Profit)

What is the Difference Between Gross Profit and Net Profit?

Frequently Asked Questions

Is gross profit higher than net profit?

Yes, gross profit will always be a higher figure than net profit. Why? Because net profit is calculated by subtracting all other operating expenses from the gross profit. The only situation where they would be the same is if a business had zero operating expenses, which is very unlikely.

Should my gross profit be higher than my operating costs?

Absolutely. For a business to be profitable, its gross profit must be high enough to cover all its other operating expenses. If your gross profit doesn't cover these costs, your business will end up with a net loss, meaning it's losing money overall.

What is a good profit margin?

A "good" profit margin really depends on your industry. Margins are usually shown as a percentage to make them easier to compare.

You can calculate your profit margins using these formulas:

• Gross Profit Margin = (Gross Profit / Total Revenue) x 100
• Net Profit Margin = (Net Profit / Total Revenue) x 100

So, what numbers should you aim for? A retail business might see a gross profit margin of around 50%, whereas a software company’s could be as high as 90%. For net profit margin, a common benchmark is 10%, but this also varies widely. The best way to judge your performance is to see how your margins compare to other businesses in your specific sector.

Take Control of Your Business’s Financial Health

Gross profit shows if you're making money from your core business. Net profit is what's left after all your bills are paid. Both are key to a healthy business.

But tracking them can be a headache. Debitam puts your finances on autopilot, giving you a real-time view of your profits. Stop guessing and start making moves. Ready to take control?