Generating a profit is incredibly significant for any firm to be in the market. It highlights the importance of estimating the firm’s profit. However, different metrics determine the profitability of a firm in different ways.
Gross profit and net profit are two methods of evaluating a firm’s profitability. Though superficially, they might seem similar, the differences between the two become apparent on scrutiny.
Comparison Between Gross Profit And Net Profit
|Parameters||Gross Profit||Net Profit|
|Meaning||It is the profit estimated by subtracting the costs of goods sold from the total revenue.||It is the profit estimated by subtracting all the operating and non-operating expenses from the gross profit.|
|Formula||Gross Profit = Revenue – Cost of Goods Sold||Net Profit = Revenue – Costs of Goods Sold – Other Operating Costs – Non-Operating Costs|
|Purpose||It helps in controlling or managing the variable costs.||It determines the financial situation of a firm.|
|Income Statement||It is the first and foremost profit disclosed in the income statement.||It is the last profit determined in the income statement.|
Explanations Of Gross Profit And Net Profit
What is meant by Gross Profit?
When a firm’s profit is estimated by deducting the cost of all goods sold from the revenue, it is known as gross profit.
Here, the cost of all goods sold refers to the total cost of producing and selling the goods or services. And revenue is the total income the firm earns by selling goods or services.
It is essential to mention that the costs included are only variable costs, that is, the costs that vary with the quantity of goods produced.
What is meant by Net Profit?
Net profit is a crucial measure of a firm’s profitability. It is because net profit is estimated by subtracting all the firm’s expenses from its total revenue.
Here, the total expenses include the costs of production and selling and other costs that the firm has to bear, like taxes, depreciation, and interest on loans.
It should be noted that while calculating net profit, all the income generated from different sources by the firm is also added.
Major Differences Between Gross Profit And Net Profit
- Gross Profit- The profit obtained after deducting the cost of manufacturing and selling goods from the revenue earned is known as gross profit.
- Net Profit– The profit left after deducting all the expenses from the total revenue is known as net profit. All the expenses encompass production costs, operating costs, different types of taxes, depreciation, and interest paid on loans and debts.
- Gross Profit- The formula of gross profit is given by: –
Gross Profit = Revenue – Cost of Goods Sold
- Net Profit- Net profit can be calculated by using the formula: –
Net Profit = Revenue – Costs of Goods Sold – Operating Costs – Other Financial Costs – Taxes – Interests on Debts + Other Income
Net Profit = Gross Profit – Operating Costs – Other Financial Costs – Taxes – Interests on Debts + Other Income
- Gross Profit- Gross profit is an important indicator of how a firm utilizes its resources, mainly raw materials, and labor, to produce goods and services. In addition, it points toward how effectively it is managing its resources.
Another reason gross profit is vital is that it includes the factors under the firm’s control. So, the firm can adjust certain factors affecting the gross profit and influencing its value.
- Net Profit- Net Profit is the ultimate indicator of a firm’s overall financial position. So, it is helpful for the employers of a firm because it enables them to devise strategies to improve their financial standing.
Moreover, net profit plays an essential role in conveying a better image of the firm to its shareholders, and it also aids in attracting investors.
- Gross Profit- In the income statement, the first two components are revenue and costs of goods sold. It is only after these two components that the gross profit is determined. Therefore, it can be said that gross profit is the topmost level of profit in the income statement.
- Net Profit– In the income statement, net profit is revealed after the gross and operating profits have been estimated. That is why net profit is also known as the bottom line.
- Gross Profit- Let us suppose a firm is earning a revenue of $100,000. By adding up all the variable costs, the costs of goods sold turn out to be $45,000. So the gross profit can be calculated as: –
Gross Profit = $100,000 – $45,000
Which equals to $55,000.
- Net Profit- The same firm with revenue of $100,000 and costs of goods sold of $65,000 has other expenses like rent, taxes, and interests on debt worth $16,000. Then the net profit can be calculated as: –
Net Profit = $55,000 – $16,000
Which equals $39,000.
Frequently Asked Questions (FAQs)
1. How many categories of profit are there?
Profit is broadly divided into three types. These are gross profit, operating profit, and net profit.
2. Why is gross profit calculated?
Gross profit gives a revelation about the way in which a firm is dealing with the resources that are available for the production of the goods. It enables the firm to take control over the costs of production.
3. What is net profit called?
The other term commonly used to refer to net profit is net income. It is because net profit is the final income left after all the expenses have been deducted.
Since it is the endmost profit level in an income statement, it is also called the bottom line.
4. What is the net profit margin?
When net profit is divided by the total revenue generated, and the result is multiplied by 100, then net profit margin is obtained.
5. Which is higher; net profit or gross profit?
Since net profit is evaluated by deducting all the expenses from the total revenue, while gross profit is calculated only by subtracting the cost of goods sold, gross profit is higher than net profit.
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