What's the difference between gross profit and net income?
24 Mar 2022
If you’re looking to invest in shares in a company, you need to know how the business is doing. Is it profitable or not? That’s why it’s important to know the difference between gross profit and net income.
The gross profit of a company is the amount of money it makes in sales, minus the cost of goods sold (sometimes referred to as COGS), says the federal government’s business advice website. The figure can also be referred to as gross income.
But gross profit does not factor in the operating expenses of a company.
That’s why it says net profit may be a better indication of profit of a business, because that does factor in the business’s operating expenses.
According to the Australian Taxation Office, operating expenses (also known as working expenses or revenue expenses) are the everyday costs you incur to run a business. These could include things such as rent, insurance premiums and advertising costs.
Example: Gross profit vs net income
The government’s business website offers up a simple example to illustrate the difference between gross profit and net income. (It actually uses the term net profit, but we’ll come to that later.)
In a typical month, a hypothetical business sells 30 products at $15 each. Each product costs $10 to produce. The operating costs for the month are $80.
From those figures it’s a simple calculation to work out the gross profit and net income for the business for that month.
The sales figure is 30 × $15 = $450 while the cost of goods is 30 × $10 = $300
Gross profit = sales − cost of goods = $450 − $300 = $150
Net profit = gross profit − operating costs = $150 − $80 = $70
That’s a difference of $80 between the gross profit and the net profit.
Which profit figure should investors look for?
There are many ways a company can report its profit, so as a potential investor it’s helpful to know which figure may give you a better indication on performance.
A good gross profit can indicate a business is providing goods or services that are in demand. It can also indicate that a company may be able to generate more gross profit if it can increase sales and reduce the production costs.
But if you want a fuller picture of how profitable a business is, you need to factor in its operating costs too. It’s a good thing to produce something that sells at a profit, but not so good if those profits are eaten up by other costs.
Tom Delany, a Senior Lecturer in Taxation Law at the University of Southern Queensland, told Canstar the terms net profit and net income are used interchangeably.
“Net profit provides a better indication of profit, as it includes the firm’s operating (overhead) expenses and shows a more complete picture of the economic performance of the firm,” he said.
Gavin Swan, a Fellow of CPA Australia and Director of Absolute Accounting Services, agreed that net profit and net income meant the same thing: the profit left after paying all expenses, including overheads.
“The problem is that there are too many interchangeable terms, some terms are investor-driven and some are Amercansims, and some are determined by which corporate you work for,” he told Canstar
“Many places look at gross profit because many overhead costs are fixed, so the number that guides profitability is gross profit.
“As accountants and certainly in the tax space, we are interested in net profit, because that more closely approximates your taxable income and also what you are able to distribute to shareholders.”
It’s that potential for the distribution of profits, paid as dividends, that might make you interested in investing in a particular company. But remember that past performance of a company is not always an indication of its future performance.
Obviously there are other factors you should consider before investing in a company, and it might be wise to seek some independent financial advice. But at least you now know the difference between gross profit and net income (or net profit).
Cover image source: kangshutters/Shutterstock.com
This article was reviewed by our Sub Editor Tom Letts before it was updated, as part of our fact-checking process.
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