Net Profit & Gross Profit: The Key Differences

Business Profit from Colout Accounting from The Holst GroupNet Profit & Gross Profit: The Key Differences

The word profit can take on several meanings. Understanding the difference is one of the many benefits of financial literacy training.

Your CEO could be talking about any number of things when referring to profit:

  • Gross profit
  • Net profit
  • Quarterly profit
  • Group profit
  • Operating profit

They’re all different, and important, in their own way. However, the two most common variables of profit are gross profit and net profit.

Gross profit

Gross profit is Revenue minus Cost of Goods Sold. For example, imagine you own a company that buys widgets from China for £2 and sells them locally for £3. Your gross profit on each widget will therefore be £1. Assuming you sell 1,000 widgets during the year, your gross profit might look something like this:

Sales £3,000 – Cost of Goods Sold £2,000 = Gross profit £1,000

A healthy gross profit is important because it represents the viability of your business model. Obviously, you need to sell products for more than the price you bought them at. If your gross profit is too low, you’ll need to find a cheaper supplier, raise your prices, or find a new product altogether.

Net profit

Obviously buying products isn’t the only expense on a business’s accounts. They also need to rent a store to display everything, hire someone to clean all the windows, take out insurance in case of a burglary or fire and hire a few good people to look after the store each day. These are known as operating expenses, and to calculate net profit, all of these need to be deducted as well. The income statement usually carries this information, and a simplified version might look like this:

Sales £3,000

Cost of Goods £2,000

GROSS PROFIT £1,000

Wages £200

Rent £200

Insurance £200

NET PROFIT £400

As you can see, while gross profit is important, it is only half the challenge in creating a profitable business. A company must add a high enough mark-up to its products/services so that it can cover all expenditure. Only then is a net profit achieved, which represents a healthy, profitable operation.

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