Introduction

If you are an investor with a long-term outlook, it is crucial to evaluate a company’s profitability and determine whether it makes for a good investment. Before you run through various profitability ratios, you must understand what the gross profit is and what it indicates. You must also be aware of what the net profit is and how it differs from the gross profit, so you can evaluate a company’s profitability more effectively.

So, in this article, we discuss the meaning of these two metrics and delve into the differences between gross profit and net profit.

Gross Profit: Meaning and Calculation

The gross profit of a company is the total revenue that remains after accounting for the costs of production. These costs include the expenses associated with manufacturing the company’s core products or creating its core services. In other words, the gross profit is a measure of how profitable the company’s core business activities are.

To find the gross profit, you must use the following formula:

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

COGS here includes various manufacturing expenses like direct material costs, labour costs, equipment costs, utility expenses and the like.

Net Profit: Meaning and Calculation

The net profit of a company represents the net gains that remain after you subtract the total expenses incurred from the total revenue earned. Unlike the gross profit, which only considers the manufacturing costs, the net profit also takes into account other expenses like operating costs, taxes, interest payments, depreciation and the like.

To find the net profit, you can simply find the difference between the total revenue earned and the total expenses incurred during a given period. Alternatively, you can use the gross profit to find the net profit, as per the formula given here:

Net Profit = Gross Profit — Other Expenses

The expenses mentioned in the above formula include all costs that do not form a part of COGS.

Gross Profit Vs Net Profit: The Key Differences

Now that you have seen what the gross profit is and what the net profit is, let us take a closer look at how they compare with one another. The gross profit vs net profit table below sums up the differences between the gross profit and net profit.

Particulars	Gross Profit	Net Profit
Meaning	The difference between the total revenue and the cost of goods sold (COGS)	The difference between the gross profit and all other operating expenses, taxes, interest and other costs
Significance	Tells you how well a company manages its production costs	Tells you about a company’s overall profitability
Components in the Calculation	Includes only the revenue and COGS	Includes the gross profit, interest, operating expenses, taxes and other costs
Formula	Gross Profit = Revenue — COGS	Net Profit = Gross Profit — (Operating Expenses + Interest + Taxes + Other Expenses)
Purpose	To measure the efficiency of a company’s production and core business activities	To evaluate the overall profitability of a company after considering all expenses
Focus	Focuses on the direct costs associated with production	Focuses on all the aspects of a company's financial activities
Useful for	Members of the management who wish to assess operational efficiency	Investors, stakeholders, and management members who wish to assess overall profitability
Indicator of	The production efficiency and the ability to generate profit from core activities	The overall financial health and performance of the company
Non-Operational Costs	Excluded from the gross profit	Included in the net profit
Example	If a company sells products worth Rs. 10,00,000 and has a COGS of Rs. 3,00,000, the gross profit is Rs. 7,00,000.	If the same company has operating expenses of Rs. 2,00,000, interest costs of Rs. 50,000 and tax payments of Rs. 1,00,000, the net profit is Rs. 3,50,000.
Accounting Treatment	The gross profit is found on the credit side of the trading account.	The net profit is found on the credit side of the profit and loss account.

Also Read: Check These Ratios Before Investing in a Stock

Conclusion

The gross profit and the net profit form the basis of various profitability ratios that are central to fundamental analysis. Now that you know what the gross profit is and what the net profit is, you can better appreciate the role these metrics play in analysing a company’s intrinsic value and investment viability.

To find the details of the net profit, operating profit, net profit margin and other financial metrics in one place, check out the Motilal Oswal Research 360 platform. Here, you can also look into the other financial details of the companies you are interested in, like their income statement and balance sheet figures, cash flow details, key financial ratios and shareholding patterns.

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