The differences between net and gross profit (and how to calculate them)

To understand the financial health of your business, you need to focus on two types of profits in particular — net and gross. Because without a clear picture of the financial health of your business, you’re operating blindly, and that means you can’t make informed decisions about the future.

Gross profit (also known as gross income) is the profit a company makes after deducting production costs, and net profit (known as net income) is the profit you have left over after deducting all expenses — insurance, taxes, wages etc.

So if you’ve come across both terms before but never really understood the difference between the two, this blog is for you. Read on to learn more about each type of profit and how you can calculate them for your business.

What is gross profit?

Gross profit, operating profit, if you’re in the manufacturing industry, is the figure you get when you remove production costs from your revenue. Gross profit or gross income, helps you understand the costs of labour and production for your business, which will help indicate whether you’re operating at a loss.

If you’re operating at a loss, you’ll want to focus on reducing production costs and improving efficiencies in the production process.

How to calculate gross profit

To calculate gross profit, you’ll need to remember this formula:

If you operate a service business, you’ll subtract the time it’s taken you to deliver the service from your revenue, and if you operate a product business, you’ll subtract the cost of production. Costs can include labour, raw materials, and overheads from factory production.

Keeping on top of this metric means that from month to month, you can clearly pinpoint when gross profit drops, which might highlight the need to make changes, perhaps improving efficiencies or raising the price of goods.

What is net profit?

Net income, simply known as the ‘bottom line’ is the figure you arrive at when you’ve subtracted all your expenses. This figure helps business owners understand the true profitability of their organisation.

You can generate thousands of pounds in revenue, but if your outgoings are high, your net profit becomes smaller (or negative, known as a net loss), which indicates that your business might need some optimising to maximise profits. You can maximise profits by making staff cuts, for example, or comparing business energy deals to reduce costs.

How to calculate net income

You can’t work out your net income without first knowing your gross profit. In simple terms, to get your net income subtract operational expenses from your gross profit:

This financial analysis helps you get a clearer picture of how your business is performing as time goes on.

Measuring net income means you can identify problems as the months progress. Giving you the chance to closely analyse your expenses, making changes for the better.

Net profit is a crucial part of understanding the financial health of your business, particularly if you’re looking to secure investors to help grow your business. Investors will look at your net profit to determine whether investing in your business is a good move or one best to avoid.

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