Business organizations produce goods and services to satisfy their investors. Investors are given profits from the revenue earned by the company quarterly or yearly. Profits are the earnings of the company after the deduction of all expenses. The gross profit and net profit are estimated to know the financial health of the organization. These two terms take different expenses to calculate the profit of the organization.
Gross Profit vs Net Profit
The main difference between gross profit and net profit is gross profit is invaded by subtracting the total cost of goods sold from the total yield. On the other hand, net profit is obtained by subtracting the indirect and direct expenses from the total yield. Gross profit gives rough profits, but net profit gives real profits.
The gross profit is the expected profit that may or may not achieve after the sales of all products. The gross profit only includes the direct expenses incurred for producing the goods and services. The direct costs are deducted from the revenue of the company. It shows how the company is using its resources like labor, infrastructure, and materials in the production process.
The net profit is the actual profit earned by the company in a particular accounting period. It is invaded by deducting all the indirect expenses from the gross profit or both direct and indirect costs from the total revenue. It is shown in the financial statement to attract investors and create effective strategies to improve business performance.
Comparison Table Between Gross Profit and Net Profit
| Parameters of Comparison | Gross Profit | Net Profit |
| Objective | Gross profit is used to measure the efficiency of management in using company resources. | Net profit is used to measure the financial condition of the company in the market. |
| Costs included | Direct or explicit costs are included in gross profit calculation.. | Indirect costs or implicit costs are included in the net profit calculation. |
| Inclusion | Gross profit is included in the income statement of the company above net profit and under the revenue. | Net profit is included in the income statement in the last line, under the retained profits heading. |
| Formula | GP= total revenue –the cost of goods sold | NP= GP- all indirect expenses. |
| Profitability analysis | Gross profit margin is used to gain knowledge of the average gross profit earned for each sale of the good. | Net profit margin is used to know the percentage of net profit earned from the total revenue after deducting all expenses. |
What is Gross Profit?
Business organizations earn profit by producing products and services to fulfill the needs of customers. To measure profitability, organizations use metrics like gross profit and net profit. Revenue is the total income earned by the company by selling produced goods and services.
Profit is the money retained by the company after deducting the cost of production of goods. The gross profit includes the direct costs incurred in the manufacturing process such as material costs, shipping charges, transportation, direct labor costs, and other costs that are directly incurred during the manufacturing process and which can easily be estimated.
The gross profit is included in the financial statement to show the operational efficiency, management capabilities in using company resources. The overall gross profit is analyzed using the gross profit margin. The gross profit margin is obtained by dividing the gross profit by net sales. It gives expected profit for the financial year and is not used in developing business strategies. It gives the margin in percentage to help managers compare their profit margin with other competitors.
What is Net Profit?
Net profit is the other important metric to measure the profitability of the organization. It is the overall profit retained by the company after paying all the direct expenses, debt, taxes, salaries, and other indirect expenses. The net profit includes expenses incurred in every department of the organization.
The net profit in the balance sheet attracts investors and shareholders. It can be improved by reducing overhead costs, travel expenses, and increasing sales. The net profit is essential for the company to achieve competitive advantages. It helps the company to get loans from banks and attract new investors, talents.
The net profit is transferred to the capital account if the business is a partnership business, and the corporate business transfer the amount into the profit and loss account. It helps to increases sales as well as prepares better strategies for future profitability. The net profit gives more insights to the management about the company’s health in the market than the gross profit. It is one of the essential metrics to determine the actual profit earned by the company in the current financial year.
Main Differences Between Gross Profit and Net Profit
- The gross profit helps to track the management efficiency, while the net profit helps to track the financial health of the company in the market.
- Gross profit is analyzed using the gross profit margin, while the net profit is analyzed using the net profit margin.
- Gross profit is measured by deducting the explicit costs from the revenue, while net profit is measured by deducting both implicit and explicit costs from the total revenue.
- Gross profit is inserted under the revenue, and net profit is appended in the last line of the financial statement.
- Net profit gives more insights into the business efficiency than gross profit.
Conclusion
Financial statements are prepared by the company every year to track performance, operational efficiency, and profitability. The financial statements include both gross profit and net profit. These are the profit earned by the company after all the taxes, indirect expenses, direct expenses, production overhead costs are deducted from the overall company income. It helps the company to showcase the management efficiency and the company profitability to the existing investors and shareholders and attract new investors.
References
- https://www.google.co.in/books/edition/A_Text_Book_of_I_S_C_Economics_Vol_II/ubjiXNPH3cUC?hl=en&gbpv=1&dq=books+on+gross+and+net+profit+theory&pg=PA244&printsec=frontcover
- https://link.springer.com/content/pdf/10.1007/0-387-29903-3_1.pdf