Gross Profit vs. Net Profit | Definitions, Formulas, & Examples

Running a business is never easy. You have to look after all facets of your business and handle competition like a pro. You may have a fascinating concept, but it may become difficult to survive in this competitive world if your business does not generate profits.

When it comes to profits, people often get confused between gross profit vs. net profit. Both types of profits are essential for framing the quarterly and annual income statements. But, what is gross profit vs. net profit all about, and should you be concerned about the differences while preparing or decoding a company’s income statement? Move on to learn more.

For an easier understanding, the following sections have been divided into the following sections:

What is Profit?

Before understanding gross profit vs. net profit, it is crucial to know the meaning of the term ‘Profit.’

Profit is when the returns are higher than the investment. So, if you invest INR 1 crore in a business venture and get INR 2 crore after one year, your profit is INR 1 crore. However, calculating the profit is not always as simple as this equation. Irrespective of whether you make profits or not, you have to pay central and local government taxes. Add to that the fixed and discretionary expenses, and you have to forego a considerable sum from your profits.

So, the actual amount of profit is seldom the same as the purported or perceived profit. This brings us to the concept of gross profit vs. net profit. The following sections discuss the meaning, examples, and calculation method of gross profit vs. net profit so that you can calculate the figures efficiently to evaluate a company’s performance better.

Gross Profit - Definition

Gross profit is the first element in the gross profit vs. net profit debate. To calculate the gross profit, you need two figures - total revenue and the Cost of Goods Sold or COGS.

Revenue refers to the net amount a company earns in a specific financial period, such as quarterly, half-yearly, or annually. Revenue is also referred to as the Net Sales provided it includes discounts and returned goods’ refunds. Conversely, COGS consists of the production and manufacturing costs of the goods a company plans to sell. COGS also includes labor costs, raw material costs, maintenance and repair costs, shipping charges, production utilities, and equipment costs.

The gross profit of a company gets listed in the Trading Account. It denotes a company’s actual earnings before deducting expenses in all forms. In the gross profit vs. net profit debate, gross profit gets the upper hand since it displays how efficiently a company uses its labor, raw materials, and supplies. So, the gross profit shows how tactically a company manages its pricing and production to stay competitive and profitable.

Now that you know that gross profit is mandatory to make sense of the gross profit vs. net profit debate, let’s discover the method of gross profit calculation in the following section.

The Method of Gross Profit Calculation

Finding the gross profit is essential before comparing gross profit vs. net profit. To calculate a company’s gross profit efficiently, you need to find its earnings first and then deduct the expenses from the figure. The following is the simplest method of calculating the gross profit of a company:

Gross Profit = Total Revenue (minus) Cost of Goods Sold

Suppose ABC Ltd. has earned a revenue of INR 10 lakh in the financial year 2021-22, and its COGS is INR 1 lakh. So, the gross profit of ABC Ltd. will be 10,00,000 - 1,00,000 = 9,00,000 or 9 lakh.

Let us get one step ahead in the gross profit vs. net profit debate by briefly understanding net profit in the following section.

Net Profit - Definition

Net profit is the second and one of the most vital elements in the gross profit vs. net profit debate. Net profit refers to the total revenue left with a company after paying central, state, and local taxes, operating expenses, COGS, liabilities, and interest. Besides the income, net profit also includes all sale proceeds and interest on investment. Also, the operating expenses contain the salary, rent, utilities, and depreciation.

Unlike gross profit, the net profit is listed in the Profit and Loss Account. Since the net profit comes at the end of the Income Statement or Balance Sheet, it is also known as the ‘Bottom Line.’

Net profit is a crucial element in the gross profit vs net profit debate. It speaks volumes about the concerned company’s profitability. It also describes how the company plans to use the sales to drive profits. Moreover, the net profit enables business owners to analyze and develop strategies required to boost the company’s profitability and financial standing. It also helps investors identify good quality companies from a pool of companies in the same business segment.

The Method of Net Profit Calculation

Finding the net profit is essential to make sense of the gross profit vs. net profit debate. To calculate a company’s net profit, you must know two figures - the gross profit and total expenses. The following is the simplest method of calculating the net profit of a company:

Net profit = Gross Profit - Total Expenses

Let us understand the net profit calculation formula with an example. Suppose ABC Ltd. has made a net profit of INR 10 lakh in the financial year 2021-22. And, it has accumulated rent expenses of INR 20,000, salary expenses of INR 50,000, depreciation of INR 2,000, and paid a tax of INR 1 lakh. So, the net profit of ABC Ltd. in 2021-22 will be as follows:

Net Profit = 10,00,000 - (20,000+50,000+2,000+ 1,00,000)

Net Profit = 10,00,000 - (1,72,000)

Net Profit = 8,28,000

Remember, if the result of this calculation is negative, it is treated as ‘Net Loss.’ As a fact, a company with a positive gross profit may register a net loss since the company’s accumulated expenses determine the profit or loss.

Now that you know the definition and calculation method of gross profit vs. net profit, let’s understand the differences in a tabular form in the following section.

Gross Profit vs. Net Profit - The Key Differences

Gross Profit	Net Profit
The gross profit is obtained after deducting the manufacturing cost of goods sold from the total revenue.	The net profit is obtained after deducting all taxes, expenses, and interest from the gross profit.
The gross profit helps the business owner in developing strategies to cut costs.	The net profit enables investors and business owners to understand a firm’s financial stability.
The gross profit gives an indication of a company’s rough profits.	The net profit gives an indication of a company’s actual profits.
The gross profit can be found on the Trading Account’s credit side.	The net profit can be found on the Profit and Loss Account’s credit side.
The gross profit comprises the labor cost, raw material cost, maintenance and repair costs, shipping charges, production utilities, and equipment costs.	The net profit comprises the taxes, interests, and operating expenses.
The formula for calculating the gross profit is ‘Gross Profit = Total Revenue - COGS.’	The formula for calculating the net profit is ‘Net Profit = Gross Profit - Total Expenses.’

Gross Profit Vs. Net Profit - Profitability Ratio

Investors, business owners, and financial experts evaluate the profitability ratio to gauge a company’s financial proficiency. It is essential to understand gross profit vs. net profit to understand the profitability ratio.

The profitability ratio demonstrates how skillfully a company uses its resources to maximize profits. The profitability ratio can be of three types - gross profit ratio, gross profit margin ratio, and net profit margin ratio. Let’s understand each profitability ratio briefly.

Gross Profit Ratio

The gross profit ratio refers to the relationship between a company’s total sales revenue and its gross profit. It also estimates the total income a company must generate to manage its operating and non-operating spending. The formula to calculate the gross profit ratio is mentioned below:

Gross Profit Ratio = Gross Profit / Total Sales Revenue

Gross Profit Margin Ratio

The gross profit margin ratio helps analyze the efficiency of a company in managing its revenue. Business owners analyze this ratio to figure out how optimally it uses the labor, equipment, and raw materials. You can calculate the gross profit margin ratio by using the formula mentioned below:

Gross Profit Margin Ratio = 100 x (Gross Profit / Total Sales Revenue)

Net Profit Margin Ratio

Understanding the net profit margin ratio is important for everyone willing to learn about the real meaning of gross profit vs. net profit. This ratio helps the stakeholders understand the relationship between the total sales revenue and the after-tax net profit. The net profit margin ratio is a crucial figure since it displays a company’s profit trends. You can calculate the gross profit margin ratio by using the formula mentioned below:

Net Profit Margin Ratio = 100 x (Net Profit / Total Revenue)

Now that you know what the relation of profitability ratio is with gross profit vs. net profit, let’s understand the profitability ratio with an example.

Suppose ABC Ltd.’s annual sales revenue is INR 1,00,000, gross profit is INR 40,000, and accrued expenses are INR 10,000.

Considering the data mentioned above, the gross profit ratio, the gross profit margin ratio, and the net profit margin ratio will be as follows:

Gross Profit Ratio = Gross Profit / Total Sales Revenue

Gross Profit Ratio = 40,000 / 1,00,000

Gross Profit Ratio = 0.4%

Gross Profit Margin Ratio = 100 x (Gross Profit / Total Sales Revenue)

Gross Profit Margin Ratio = 100 x (40,000/1,00,000)

Gross Profit Margin Ratio = 40%

Net Profit Margin Ratio = 100 x (Net Profit / Total Revenue)

Net Profit Margin Ratio = 100 x (40,000 - 10,000 / 1,00,000)

Net Profit Margin Ratio = 100 x (30,000 / 1,00,000)

Net Profit Margin Ratio = 30%

When it comes to which is more important, gross profit vs. net profit, net profit rules the show. Net profit determines the true worth of a company. The net profit plays a pivotal role in attracting investors. Moreover, a decent net profit satisfies a company’s stockholders. The net profit also helps an investor choose the best company of companies with varying gross profits.

Conclusion

There is no clear winner in the gross profit vs. net profit debate since both figures are equally important in determining a company’s financial strength, stability, and performance. While gross profit speaks volumes about a company’s utilization of labor, capital, and raw materials, net profit enables investors to evaluate the profitability of a firm.

So, the ultimate winner of the gross profit vs. net profit debate depends on the angle from which you evaluate both.

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Key Takeaways

When it comes to profits, people often get confused between gross profit vs. net profit
The gross profit of a company gets listed in the Trading Account. It denotes a company’s actual profits before deducting expenses in all forms
To calculate the gross profit of a company efficiently, you need to find its earnings first and then deduct the expenses from the figure
Net profit refers to the total revenue left with a company after paying central, state, and local taxes, operating expenses, COGS, liabilities, and interest
To calculate a company’s net profit, you must know two figures - the gross profit and total expenses
While gross profit speaks volumes about a company’s utilization of labor, capital, and raw materials, net profit enables investors to evaluate the profitability of a firm