Net Profit vs Gross Profit
Those who are into business know very well that there are glaring differences between gross and net profits and keep their profit margin at levels that they end up with some profit after taking into account all expenses. This is an important dichotomy for those who have never done business before and are planning to start a business of their own. Knowing the difference between gross and net profits is often the difference between success and failure for budding entrepreneurs. This article makes difference between gross and net profit clear for all readers.
Any entrepreneur is only interested in knowing how much profit he made at the end of the day, isn’t it? If you find that even after selling all items, you are actually making a loss instead of profit at the end of the day, you would not believe saying there must have been some pilferage or theft as you had kept 25% margin, and thus, should have money in hand as profit at the end of the day. This is where the concepts of gross profit and net profit come in handy in understanding what went wrong.
To begin with, gross profit is all receipts from sales minus the cost of procuring/producing goods. Suppose you are selling readymade T-shirts, and you bought them at $10 a piece and bought 100 T-shirts to spend $1000 in all. You decided to sell T-shirts at $15 per piece, and sold all 100 to generate sales of $1500. It is clear then that in a total sale of $1500 where you invested $1000, your gross profit is 33 1/3 % ((1000/1500) x 100 = 33.33%). ‘Total revenues minus total cost of goods’ is referred to as gross profit, and it does not take into account any operating expenses. On the contrary, net profit is arrived at after deducting all operating expenses from gross profit. Supposing your operating expenses were $200, your net profit comes down to 1500-1200 = 300 or (300/1500) x 100 = 20%. What does this imply? Despite keeping a margin of 50% on goods, your net profit is down to 20% because of operating expenses.
If in the month of December, you try to compete with other shops and announce a discount of 20% on your stock, you will find that despite increasing your sales, you are actually making a lesser profit. Let us see how. As your purchase and expenses remain the same, in a sale of 200 T-shirts, you are generating revenues of $2400, so your gross profit now is $400 which turns out to be (400/2000) x 100 = 20%. But, after subtracting operating cost from this gross profit, you arrive at a figure of $200 ($400- $200 = $200). Thus, your net profit is just $200, which means that net margin is now (200/2000) x 100 = 10%.
From the above example, it is clear that to have a higher net profit, one needs to keep his margin of profit higher. Thus, one cannot keep low prices just to be competitive as he will make a loss instead of profits in his business.
What is the difference between Net Profit and Gross Profit?
• Gross profit is total sales minus total cost of goods. It does not take into account operating expenses.
• Net profit is arrived at after deducting operating expenses from gross profit.
• In most businesses, net profit is always lower than gross profit.