The difference between net income and net profit can be quite confusing since both these terms are often used interchangeably. However, it is important to understand different components that are included in each of these concepts since both provide various indications.The key difference between net income and net profit is that net income is the funds available for shareholders after tax, while net profit is the actual total profit earned by the company. Net Profit calculation includes all the operating and non- operating incomes and expenses.
CONTENTS
1. Overview and Key Difference
2. What is Net Income
3. What is Net Profit
4. Side by Side Comparison – Net Income vs Net Profit
5. Summary
What is Net Income?
Net income is the profit available for company’s shareholders after the tax payment. Thus, it is also referred to as Profit after Tax (PAT) or Net Earnings. In other words, it is the net increase in shareholder’s equity. Net profit will be used to pay dividends to shareholders and/or transferred to earnings reserved.
Net income is a very useful aspect as it is used to calculate two main financial ratios. They are,
Earnings Per Share (EPS)
Governed by IAS 33, this is the amount of net income earned per share of stock outstanding and is calculated as per below.
EPS= Net income / Number of average shares outstanding
Higher the EPS, the better; since it indicates that company is more profitable and the company has more profits to distribute to its shareholders.
Return on Equity (ROE)
ROE expresses how much profit is earned for each unit of shareholder equity; thus a good ROE is an indication that the company is utilising shareholder funds efficiently and is calculated as below.
ROE= Net income / Average shareholder equity *100
Figure_1: Profit after tax is the Net Income
What is Net Profit
In simple accounting terms, net income can be summarised as the summation of total income less total expenses, thus, it is the actual profit earned by the company. Net income is an indication of the financial robustness of the company. If the total expenses exceed the total revenues, then the company incurs a net loss.
In calculating net income, the following should be considered.
Revenue
Income earned by conducting company’s main business activity
Cost of Goods Sold (COGS)
The cost of goods in the beginning inventory plus the net cost of goods purchased minus the cost of goods in its ending inventory.
Gross Profit
Gross profit is the revenue less cost of goods sold and is calculated by Gross Profit margin (GP margin). This shows the percentage of revenue left after covering the cost of goods sold. Higher the GP margin, higher the efficiency in conducting the main business activity.
Gross Profit margin= Gross Profit / Revenue *100
Operating Expenses
Operating profit/ Earnings before interest and tax
This is the gross profit less operating expenses. Operating profit is an important measure of efficiency since it demonstrates how profitable the core business activity is. This is measured by the Operating profit margin ratio (OP margin).
Operating profit margin= Operating profit/ Revenue *100
Interest Expense
Interest paid on debt finance such as loans
Interest Income
Interest received on cash deposits or similar investments
Tax
Compulsory payment levied by the government
Net Profit margin (NP margin) is calculated using this final profit figure and is an indication of value generation by the company.
Net Profit margin= Net Profit/ Revenue *100
Figure_2: Factors affecting Net Profit
What is the difference between Net Income and Net Profit?
Net Income vs Net Profit |
|
| Profit is available for company’s shareholders after all payments. | Net profit refers to total income less total expenses. |
| Usefulness | |
| This indicates total profitability | This indicates the shareholder value generation. |
| Ratios | |
| Net income is used to calculate GP margin, OP margin and NP margin. | Net profit is used to calculate EPS and ROE. |
Summary – Net Income vs Net Profit
The difference between net income and net profit should be clearly distinguished in order to understand the effects of one another. Operational efficiency should be increased by minimising costs and wastage in order to increase the net profit. Since the main contributing factor for the difference between net income and net profit is a tax, which is not controllable by the company, the measures taken to improve net profit will also result in net income growth.
Reference:
1. “What Is the Difference Between Net Income & Net Profit After Tax?” Chron.com. N.p., n.d. Web. 06 Feb. 2017.
“Operating Income.” Investing Answers. N.p., n.d. Web. 06 Feb. 2017.
“IAS Plus.” IAS 33 – Earnings Per Share. N.p., n.d. Web. 06 Feb. 2017.
Fuhrmann, CFA Ryan C. “How do you calculate return on equity (ROE)?” Investopedia. N.p., 30 Dec. 2015. Web. 06 Feb. 2017.
“Financial Ratio Analysis | Example.” My Accounting Course. N.p., n.d. Web. 07 Feb. 2017.
Images:
1. “Tax”(CC BY-SA 2.0) via 401kcalculator.org.