What Is The Difference Between Gross Profit & Net Profit?

Ordinary people often can't tell the difference between gross profit and net profit, but for accountants there are major differences between these two terms, especially in regards to their impact on a company's earnings. Both of these terms play an important role in any income statement, and are crucial in telling company owners about the profitability of their business and the severity of their expenses. So if you want to learn the difference between net profit and gross profit then the following article will help to clear up a few things.


Elements of Net Profit and Gross Profit

Before we can discuss the difference between these two terms, let us first take the time to analyse their elements. Because net profits and gross profits are different, it also follows that they are computed using different variables. So to better understand the topic at hand, let us first take time to analyse what they are made of.

What Are The Elements of Net Profit?

Net profit is usually listed on the bottom part of an income statement, and is influenced by several factors, including:

- General Expenses
- Administrative Expenses
- Taxes
- Sold Assets
- Revenue
- Income
- Salaries
- Cost of Goods Sold (COGS)

In certain cases, it can also include factors, like sales commissions, advertising costs, research and development related expenses, legal and accounting fees as well as salaries for personnel who are not related to the operations or manufacture of the company's products, such as for example, administrative personnel, marketing executives and R&D staff.

Another crucial factor in computing net profits is depreciation which measures the gradual decline in value of certain hard assets, like office equipment and furniture. Also, for certain companies, special types of taxes as well as other income items are also taken into consideration when computing net profits.

What Are The Elements of Gross Profit?

Gross Profit is calculated using fairly simple factors. These include the company's revenue or "Total Sales" and the Cost of Goods Sold (COGS) over a period of time. To compute the gross profit, simply subtract the latter from the former.

The difficult part in computing a company's gross profits are the COGS, which can include all kinds of things, including:

- Sales Cost or Production Costs
- Cost of Raw Materials
- Fuel Costs
- Transportation Costs
- Shipping Costs
- Wages for Laborers or Personnel Responsible for the Creation of Products

As you can see, all of these costs are related to the production good and services, which means that gross profits are calculated using fewer factors than those used for calculating net profits. It's also worth mentioning that gross profits are usually found in the first part of an income statement.


Gross Profit VS Net Profit

Basically, the difference boils down like this: Gross profit refers to total sales revenues minus the total cost of goods sold. On the other hand, net profit is related to several definitions. One common definition refers to all revenues minus all expenses. For example, aside from the selling their products, a particular company may also gain revenue from donations or subsidies. On the other hand, the company's expenses may not just refer to the cost of the goods sold, but also to administrative costs, taxes as well as non-operating expenses. So in order to understand the different between gross and net profit, it's important to keep in mind that the latter tends to be more complicated than the former.

Another way to understand the difference between gross and net profit is to remember that gross profits are always used to compute net profits, but not the other way around. In business accounting, gross profit can refer to all of the revenue that a particular company can earn over the course of a year. It, therefore, includes all figures on yearly cash, yearly checks, yearly credit charges, yearly rents, yearly interests, yearly dividends and many more. On the other hand, net profit begins with gross profit and then subtracts the total business expenses for that particular year. These expenses can be composed of various factors, including the cost of all the goods sold, operating expenses, interest paid, repairs as well as miscellaneous costs.

In short, the difference between gross profit and net profit is that net profit will always have a much wider scope than gross profit. Furthermore, gross profit is a critical component of net profit, which means that the two are inseparable, and both play mutual roles in each other.

The Purpose Behind Gross and Net Profit

Now that we've discussed the difference between net and gross profits, it's time to discuss how they influence most companies today. Both items are necessary in computing any company's earnings, and can tell potential investors a lot about the businesses they're investing in. So here's a brief overview of how gross and net profits influence a business's finances.

Let's begin by discussing the benefits of net profits. Net profits provide insight into a particular company's profitability. It can, for example, be used to compute earnings per share (EPS) or compare the company's stocks with those of other businesses within the same industry. To illustrate this, let's say that you're a stock investor and you want to know one of your favorite company's "earnings per share." To calculate this, simply take the company's nett profit and divide it by the total common shares currently outstanding. With this information, you will be able to better predict the value of your company's stocks.

As for gross profits, they are important because they indicate the profitability of a particular company before overhead costs, as well as the profitability of their products or services. This is important because companies which have high gross profit margins are usually more competitive than their rivals in the same industry.

Take note, however, that in order to properly examine a company's net and gross profit calculations, you will need to look at all the elements and methods used. Also you will need to look at the footnotes and comments included in their income statements as well as their balance sheets, as these can help explain a lot of important details about their computations.

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