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Difference Between Gross Profit and Net Profit

A company generates two profits: net profit and gross profit. They help businesses prepare a more comprehensive financial statement.

Are you a business owner wondering about your profit gained? Do you want a lump-sum capital from investors?
 

Then, your company needs to have the finest financial status. To prepare, you must understand gross and net profit calculations. This will help measure profit against revenue. With the knowledge gained on the company’s performance, you can expand your business and make other financial decisions.

This blog will analyse the difference between net profit and gross profit. Further, we will explain calculations with the help of real-world applications.

Understanding Gross Profit

Gross profit is gained by a business when it sells products or services. The sales include all tangible assets, not fixed assets like tools and machinery.
 

The gross income is the value we get by subtracting the total revenue and the cost of goods sold.

Formula to Calculate the Gross Income of a Company

Gross Income/Profit = Total Revenue - Cost of Goods Sold (COGS)
 

Here, the total revenue indicates the company’s overall income.

The cost of goods sold represents the income earned by sales. It comprises the following charges:
 

1. The labour involved in production

2. Raw materials and packaging materials

3. Packing and shipping charges

4. Charges for tools operation

5. Processing fee

6. Sales commissions
 

The cost of goods sold excludes insurance, rent, property tax and marketing charges. Further, it is variable, i.e., it depends on the market demand and supply.

For instance, a juice company may get raw materials at a low cost for a certain period.
 

Importance of Gross Profit

While considering income tax efiling, with gross profit, you can better understand your business's capacity to convert revenue into profit. For example, your venture is efficient if you gain high gross profit with low COGS and make charges.

You can also find ways to choose low-cost materials and a cheaper workforce. Further, you can analyse your business’s product stance in the competitive marketplace and develop effective sales strategies. Thus, promoting or dropping a product lies with the gross income.
 

Example of Gross Profit

Let’s understand gross profit with an example.
 

To calculate the gross income for a chocolate manufacturing company in a financial year:
 

COGS for manufacturing is ₹42,000, which can be expanded as:
 

1. Cocoa: ₹20,000

2. Sugar: ₹10,000

3. Butter: ₹6,000

4. Packaging: ₹2,000

5. Running Equipment Charges: ₹4,000
 

Now, subtract the labour charge and processing fee of ₹10,000.

So, the total amount spent on COGS is ₹42,000 - 10,000 = ₹32,000.

Now, let’s assume the revenue generated is ₹62,000.

So, the gross income = revenue - COGS

= ₹62,000 - ₹32,000 = ₹32,000

Therefore, the total gross income is ₹32,000.

Understanding Net Profit

Net profit is the profit gained after tax and other deductions. It is the money that your company is left with after all bills have been paid. Net profit is the income mentioned in the income statement as the bottom line.
 

Net Profit Calculation Formula

Net Profit = Gross Income - Expenses

Your business expenses may include rent, income tax, marketing efforts, insurance, retirement contributions, and other utilities.
 

Importance of Net Profit

Net income helps analyse your business’s financial health effectively. You can find loopholes in spending and expenditure to plan a comprehensive budget. Moreover, it gives a clear picture of the investment needed for your venture.
 

Example of Net Profit

To calculate the net profit for the chocolate manufacturing company, consider the expenses of the unit.

Rent for Company Space: ₹1000

Insurance and Retirement Contributions: ₹5000

Marketing Expenses: ₹3000

Other Utilities: ₹2000

Total Expenses: ₹11,000

Now, incorporate the values in the net profit formula

Gross Income - Expenses = Net Profit

₹32,000 - ₹11,000 = ₹21,000

Hence, the net profit is ₹21,000.

An Income Statement Showing Net Profit and Gross Profit

After the calculation of the net and gross income, a company prepares an income statement as shown below:

 

ABC Company

For the year ended 30 September, 2023

Total Revenue: ₹62,000

Cost of Revenue: ₹32,000

Gross Income: ₹32,000

Operating Cost: ₹4,000

Income Before Tax: ₹10,000

Income Tax Total: ₹2,000

Income After Tax: ₹8,000

Interest Expenses: ₹1,000

Net Profit: ₹9,000

 

Gross Profit vs Net Profit: What Are The Differences?

The differences between net and gross profit are analysed below:

 

Aspect

Gross Profit

Net Profit

Definition

It is the amount obtained after deducting COGS from the total revenue.

 

The total amount a company takes home after deducting all expenses, including tax.

 

Insight

It unveils the company’s efficiency in managing raw materials, labour, and manufacturing costs.    

It reveals the company’s financial situation after all expenses have been paid.

 

Calculation

Gross profit can be calculated when the revenue and COGS are estimated.

Net income can be analysed accurately only after the gross income calculation.

 

Purpose

It gives insights into the company's total profit related to the products/services.

 

Net income provides the total profit the company has earned in a particular period.  

 

Period of Calculation

It is calculated for a certain accounting period.

It is calculated for a certain accounting period.

Reliability

Gross profit is not reliable for planning a business strategy.

Net profit is a revelation of total profit, making it reliable for building a business framework.

 

Income Statement

Gross income is provided in the upper part of the income statement.

The net profit is given in the bottom line of the income statement.

Advantages

Manufacturing expenses can be controlled.

 

Expenses depend on the taxing authorities.

 

Profit/loss Calculation

Profit or loss of the company’s product can be decided.

With net income, the overall profit or loss of the company can be calculated.

Expenses

 

 

 

Gross profit expenses include tangible assets, manufacturing, and labour costs.

Net profit includes operating costs, taxes, and interest.

Formula

 

Gross Income = Total Revenue - Cost of Goods Sold

Net Profit = Gross Income - Total Expenses

Profitability Ratio: Gross Profit vs. Net Profit

The profitability ratio is the financial measurement of a company’s efficiency. The percentage calculated refers to generating a maximum profit using the availability of manufacturing units, labour costs, and other expenses.

The key parameters in assessing the profitability ratio include:
 

1. Financial statements

2. Revenue

3. Equity funds

4. Overall sales during the accounting period
 

It also acts as a comparison factor between similar industries. For example, two gold manufacturing companies selling the same product may have different profitability ratios. Usually, small businesses have a low ratio as compared to larger companies.
 

Investors look for this parameter when assessing the company’s viability. Furthermore, it encourages business owners to plan for higher profitability ratios in the future.

Gross Profit Margin Ratio

The gross profit margin ratio is commonly known as the gross margin ratio. It is the percentage of sales in a certain period.

In brief, the gross margin ratio is a company's money, deducting the cost of making charges in a percentage form.

The gross margin ratio formula is:
 

Gross Margin Ratio = (Gross Profit / Net Revenue) × 100

If a company produces a gross profit of ₹60,000 and a net revenue of ₹1,00,000, then:

₹60,000 / ₹1,00,000 × 100 = 60%
 

Net Profit Margin Ratio

The net profit margin ratio is also known as the net margin ratio. It indicates the overall profit of a venture’s profit in percentage.

Net profit margin is the metric that the stakeholders trust in a company. Consecutive good net profit margin attracts more cash flow.
 

You can calculate the net margin ratio by dividing the net profit (after subtracting the gross profit by expenses) by the total revenue multiplied by 100.
 

Net Margin Ratio = (Net Profit / Total Revenue) × 100
 

The net profit margin must always be lower than the gross margin ratio. This is because the expenses, taxes, and interests are not reflected in the gross profit margin.

A low net profit ratio means the company spends more on resources and workforce maintenance. Thus, the company’s management should analyse the budget and plan better financial strategies.
 

A high net profit ratio means the company has optimised the resources for high income. As a business, you can start expanding and investing more.

Conclusion

Understanding net and gross profit differences is essential for calculating a company's financial status.

Gross profit is a rough profit related to the products and services. The labour and manufacturing charges determine gross profit. Net profit refers to the overall profit the company generates. It is determined by other expenses your business makes.
 

Financial experts analyse these profits and prepare an income statement at the year's end. Thus, it attracts investors and stakeholders to invest in ventures for high returns.

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Tata AIA Life Insurance

A joint venture between Tata Sons Pvt. Ltd. and AIA Group Ltd. (AIA),  Tata AIA Life Insurance  is one of the leading life insurance providers in India. We post everything you need to know about life insurance, tax savings and a variety of lateral topics such as savings and investments in this space. You can access and read a host of different blogs, articles and pages at the Tata AIA Life Insurance Knowledge Center or get in touch with us with any queries or questions!

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Frequently Asked Questions

How do the cost of sales and cost of goods sales differ?

The cost of goods sales indicates the direct cost related to product building. On the other hand, the cost of sales refers to the indirect and direct costs of manufacturing.

What is an income statement?

The income statement is the financial statement prepared by the company. It gives all the details of the company’s expenses and profits gained.

How can I increase my company’s net profit?

You can increase your company’s net profit by selling more products and reducing expenses.

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  • This blog is for information and illustrative purposes only and does not purport to any financial or investment services and do not offer or form part of any offer or recommendation. The information is not and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action.
  • Please know the associated risks and the applicable charges, from your Insurance agent or the Intermediary or policy document issued by the insurance company.
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