When it comes to effectively running a business, it is important that the business owner understand the two important types of profit and how to calculate this profit. Gross profit has to do with the amount of money the business is left with after the cost of production has been subtracted. Gross profit is calculated when sales have been done and the production cost is subtracted. However, net profit is the amount of money at hand when all other expenses including the production cost have been subtracted. This implies that to arrive at the net profit, you have to do a gross profit analysis.
The major benefit of gross and net profit
On the one hand, net profit is what is left after all expenses have been subtracted while on the other hand, gross profit is the money left after the production cost has been subtracted. The gross profit helps investors and business owners to know the extent of profit a company can make from the sales of its goods and services while the net profit helps to determine the overall profitability of a company. Understanding the difference between net and gross profit helps a company owner or investors to know how much they stand to gain from the business.
How to calculate gross and net profit
To arrive at the gross profit, it is important to understand the Cost of Goods Sold (COGS) and Revenue. The cost of good sold is as the name imply. It is the amount of money spent in producing the goods a company intends to sell for a period of time, while revenue is the amount of money earned from sales of goods for a given duration.
Gross profit = Revenue – the Cost of Goods Sold.
How to calculate net profit
As pointed out already, net profit is the amount arrived at when the total expenses have been subtracted from the total revenue. Simply put, net profit is
Net profit = Revenue – total expenses
The understanding of both the net profit and the gross profit helps a business owner or entrepreneur understand how well the business is doing and the chances of business growth.
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