Net Profit, also called Net Income or Bottom Line, is an essential profitability measure at the bottom of the income statement.
The formula is total revenue minus total expenses. You could start with total revenue (at the top of the income statement) or with gross profit (further down). Since gross profit already factors in cost of goods sold (COGS), you do not have to account for it again when doing the calculations for net profit.
Net profit is the bottom line, measuring all sources of operating income, non-operating income, operating expenses, and non-operating expenses. This is both a good and bad thing, as it is comprehensive but also might have irregular transactions that make it difficult to compare period over period.
The net profit formula is total revenue minus total expenses.
Net Profit = Total Revenue - Total Expenses
Remember that total revenue is also called total income, gross income, sales revenue, and net sales.
Here are three examples for net profit. We will walk through the calculations and analyze what each company’s profits are.
Net Sales: $500,000
Company A has a very short income statement and a net profit of -$120,000. This would also be called a net loss of $120,000.
Gross Profit: $87,000
Operating Expenses: $50,000
Non-Operating Income: $1,000
Non-Operating Expenses: $10,000
Company B provides us with gross profit but not total revenue, so we are starting further down the income statement. Gross profit already includes the cost of goods sold so remember not to double count it.
At the end of the day, Company B had a net profit of $28,000.
Net Sales: $2,000,000
Gross Profit: $550,000
Non-Operating Income: $20,000
Non-Operating Expenses: $95,000
Company C provided us with net sales, cost of goods, and gross profit so we could start with either net sales less COGS (which we did) or with gross profit. The net profit for Company C was -$105,000, which would be classified as a net loss.
Gross profit and net profit are two measures of profitability. Gross profit is at the top of the income statement and looks at the profitability after factoring in cost of goods sold (COGS).
Cost of goods factors direct costs used to provide goods and services, such as: raw materials, inventory, direct labor, production equipment, and utilities attributable to production or storage.
Net profit, as discussed, looks at net earnings of a business after all revenues and expenses are included. The formula is total revenue minus total expenses.
All business activity for the accounting period, including non-operating or irregular activity, are included in this metric.
For example, if a company takes on new debt financing, the impact on the income statement would be that gross profit would remain the same and net profit would decrease. This is because interest expense is a non-operating expense that contributes to net profit.
Both ways of understanding a company’s profits are important and, all things equal, companies want a high gross profit and high net profit.
Net profit margin is net profit divided by total revenue. The profitability ratio is expressed as a percent and most commonly tracked every month.
Companies will want a higher profit margin as that allows them to repay debt, distribute funds to shareholders, or reinvest in the business to promote growth. Companies with a negative profit margin or low profit margin will have to carefully analyze their business in order to understand if it is temporary or permanent.
In the same way there is a net profit margin, there is also a gross profit margin. Gross profit margin is gross profit divided by total revenue. Operators and investors will look closely at gross margin and net margin to understand how a business is changing from one accounting period to the next.
There are certain periods, like when an early-stage startup is growing quickly, that you should not expect profit and these periods need to be clearly communicated to the team and investors.
In the normal course of business, the company’s bottom line is one of the most important financial metrics.
A high net profit margin is preferred because that money can be used to repay debt obligations, paid out as dividends to shareholders, or used to reinvest in the business for the next fiscal year.
A low net profit margin might be part of a strategy (e.g., to grow quickly and not make profit) but is also more risky because there is less room for error or to absorb changes in the market condition. At the end of the day, a company’s profit is what makes it self-sufficient.
Track metrics like the top performing ecommerce stores.