Gross Profit vs. Net Profit: What's the difference and why it matters

Gross profit and net profit each tell a different part of the story when it comes to the profitability of a business. Gross profit provides a view of profitability for a particular aspect of company operations, namely its product and service production. Net profit calculates profit for the business overall.

By understanding and evaluating these two profit measures, businesses can make more informed decisions about where to adjust production or operations and what investments may be helpful for company growth.

Read on to learn more about gross and net profit, how to calculate them and when to put them to work for your business.

What is gross profit and what does it include?

Gross profit measures, in dollars, the amount of profit a business generates on its products and which ones are profitable. Businesses can use gross profit to identify where changes may be in order with suppliers, vendors, labor or efficiency. Since it is featured at the top of a company's income statement, it is sometimes referred to as "top line."

Gross profit is calculated by subtracting the cost of goods sold (COGS) from the revenue earned from products or services. COGS includes only the direct costs needed to produce those products — such as raw materials and labor. While gross profit is a useful way to understand how efficiently a business is producing what it sells, it doesn't include fixed costs like rent, salaries or insurance. That's why it shouldn't be used alone to measure total business profitability.

The formula for gross profit is:

Revenue – Cost of Goods Sold (COGS) = Gross Profit

Since most service businesses don't have all of the traditional costs associated with product production, the gross profit formula for service businesses is slightly different. Instead of COGS, service businesses use the cost of services sold (COSS). COSS includes expenses related to providing the service, such as wages, fees and supplies.

The formula for gross profit in a service business is:

Revenue – Cost of Services Sold (COSS) = Gross Profit

It's important to note that gross profit and gross profit margin are not interchangeable. Gross profit measures, in dollars, the amount of profit on products or services created by a business. Gross profit margin is a percentage measurement that shows the profit on revenue earned.

The formula for gross profit margin is:

(Revenue – COGS) ÷ Revenue × 100 = Gross Profit Margin

What is net profit and what does it include?

Net profit, sometimes referred to as net income or "bottom line," is profit remaining after deducting all business expenses from revenue. This critical metric gauges the overall profitability of a company.

The formula for net profit is:

Revenue – Total Business Expenses (COGS, operating expenses, interest and taxes) = Net Profit

Net profit reflects how effectively a company is generating profit, i.e., whether a business makes more than it spends from its operations. When a company is making more than it spends, it may be said that it is operating "at a profit"; if it spends more than it makes, it is operating "at a loss."

Net profit and net profit margin are not the same. Net profit is expressed as the dollar amount of profit remaining after all expenses are deducted from revenue. Net profit margin is a measure of profitability and is a percentage representing the net profit as a proportion of the company's total revenue.

The formula for net profit margin is:

(Net Profit ÷ Revenue) × 100 = Net Profit Margin

What are the key differences between gross and net profit

Gross profit is an essential financial measurement for tracking profit, specifically at the product and service production level. Net profit is an important measure of a company's entire operation.

At a glance: gross profit vs. net profit

Using gross and net profit for business decisions

Gross profit and net profit are important for informed decision-making, strategic planning and cash flow management. Each metric, when used alongside other financial tracking methods, helps businesses understand how to invest, when to cut costs and what steps are important to maintain company vitality.

Specifically, here are some of the ways businesses use gross profit and net profit.

Five ways businesses may use gross profit

1. Assess costs. Low gross profit can prompt a business to look for a new supplier or negotiate vendor contracts, or seek ways to improve efficiency.
2. Evaluate products and services. Gross profit reveals which products are most profitable so businesses can refocus sales and marketing, eliminate underperforming products or make other adjustments.
3. Make informed growth plans. Knowing which products or services are profitable helps a business decide where to focus growth and invest.
4. Understand operational efficiency. When gross profit is down, an evaluation of operations can help to reveal manufacturing, delivery or supply issues or highlight opportunities for automation to save money and increase efficiency.
5. Plan financing. Insight into production strengths and weaknesses helps businesses identify where financing may be needed to improve operations, address an impending cash flow issue or otherwise stay financially strong.

Five ways businesses may use net profit

1. Manage cash flow. Sound cash flow projections are needed to track and manage cash flow, but net profit can indicate a likelihood to generate positive cash flow or a potential lack of cash flow to support businesses’ financing plans.
2. Direct company reinvestments. Net profit can inform decisions about what funds may be available for reinvesting into a company, whether that is for staff, equipment upgrades, market or product expansion or other opportunities.
3. Prove financial strength. Some investors, partners and others will evaluate net profit to assess overall business strength and financial health.
4. Support benchmarking. Net profit creates a benchmark-able metric for conducting industry or competitor comparisons.
5. Pay taxes and dividends. Taxes are based on net profits and some corporations will pay dividends from net profit.

Use profit insights to drive business growth

Gross profit and net profit are important financial metrics. By analyzing both gross and net profit, businesses learn where profit is generated and what changes are needed to maximize business potential. Gross and net profit are also used to inform business decisions and provide insight into cash management planning. Use these important metrics and other financial insights to sustain and improve business health.

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