What is net profit?

Net profit is a company’s actual profit, once all expenses are taken away from its revenue. It is used as the ultimate measure of how profitable a business is. Since it appears at the very end of financial statements, it is also known as the bottom line. 

Key takeaways

Net, gross and operating profit

Net profit, gross profit, and operating profit are different financial metrics that provide insights into a company's financial performance. Below are the key differences between them.

• Gross profit. Gross profit is the difference between revenue and the cost of goods sold (COGS). COGS refers to the direct costs associated with producing and delivering goods or services, such as labour, materials, and overhead expenses. Gross profit shows how much money a company is earning after accounting for the costs directly related to producing its goods or services.

• Operating profit. Operating profit is calculated by subtracting operating expenses from gross profit. Operating expenses include indirect costs associated with running the business, such as salaries, rent, utilities, taxes, and other expenses. Operating profit is a measure of profitability that indicates how much money the company is earning from its core business operations, before taking into account taxes and other non-operating expenses.

• Net profit. Net profit is the final measure of profitability and is calculated by subtracting all expenses, including non-operating expenses, such as debt repayments and restructuring costs, from total revenue. 

Net profit examples

Here are some examples of net profit. 

Say we have a clothes store that makes $1m a year, and spends $500,000 on rent, salaries, product to sell, taxes and so on. Therefore, it has a net profit of $500,000.

On the other hand, imagine a tech firm. It makes $5m a year, but once its rent, salaries, taxes, equipment and so on go out, that accounts for $3m revenue. This leaves it with a net profit of $2m.  

On one hand, the tech firm has a higher net profit, with it making $2m against the clothes shop’s $500,000. However, there is such a thing as a net profit margin. This shows net profit as a percentage of the company’s revenue. In other words, the net profit margin is the ratio of net income to revenues. In terms of net profit margin, the clothes shop scores higher, with a net profit margin of 50% compared to the tech company’s 40%. 

Calculating net profit

Net profit is calculated by subtracting all the expenses and costs from the total revenue earned. The formula looks like this

To calculate net profit, you will need to find out the total revenue and total expenses incurred during a given period, such as a month or a year.

Total revenue includes all the income earned from sales, services and any other sources. It is calculated by adding up all the revenue generated during the time period in question.

Total expenses include all the costs incurred to run the business, such as salaries, rent, utilities, taxes, and any other expenses.

Once you have determined the total revenue and total expenses, you can calculate the net profit by subtracting total expenses from total revenue. If the resulting number is positive, it means that the business has generated a profit. If it is negative, it means that the business has incurred a loss. 

How to analyse net profit

If someone looks at a company’s net profit, it is entirely possible that they will want to analyse it too. Here are some steps that people can take when analysing net profit:

• Take a long view. Analysing net profit over a longer time period could help someone  understand if the company is growing or declining. They could look at the net profit for the past three to five years to see if there is a consistent trend.

• Compare net profit to revenue. Comparing a company’s net profit to its revenue could give one an idea of how efficiently the company is managing its expenses. A high net profit margin might suggest it is generating a significant amount of profit for every pound of revenue.

• Compare net profit to industry averages. Doing this could help someone understand how the company is performing relative to its competitors.

• Look at what makes up net profit. Analysing the components of net profit, such as operating expenses, interest expenses, and taxes, could identify areas where the company could improve efficiency.

• Consider non-financial factors. Analysing net profit is an important aspect of understanding a company's financial health, but it is not the only factor to consider. Be sure to also consider non-financial factors such as the company's competitive position, management team, and industry trends.

Why net profit matters

• Shows the company’s financial health. A sizeable net profit suggests that a business is doing well, providing popular goods and services and bringing in more money than it is putting out. 

• Determines shareholder value. When a company is profitable, it can use its profits to pay dividends to shareholders or reinvest in the business, which can increase the value of the company's shares.

• Attracts investors. Investors are likely to be interested in companies that are profitable because they are more likely to generate returns on their investment. A company with a strong net profit can attract new investors and increase its access to capital.

• Helps decision making: Analysing net profit helps businesses make informed decisions about how to allocate resources and invest in growth opportunities. By identifying areas where the company can reduce expenses or increase revenue, businesses can make strategic decisions that will improve their overall profitability.

Conclusion

So, that should be net profit explained for you, with it defined as the difference between a company’s revenue and its expenses. It can be a useful tool in calculating a company’s financial health as well as something which can attract investors, help corporate decision making and determine shareholder value.

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