What is net profit & how to calculate it using the net profit formula
Jan 29 2022
Businesses can record high revenue but still turn in a loss. Revenue is not an accurate indicator of business profitability, but net profit is. You must understand net profit and its importance to your business' financial health. Investors and lenders are very keen on these figures before investing or lending you money.
Net profit tells you how much money you have to pay shareholders, invest or save. It's also vital for new businesses to break even, as it shows if you are making progress. You should aim to have a significant net profit margin every month for your business to grow.
In this post, you'll learn how to use the net profit formula to calculate the net profit for your company, even if you are not an accountant.
Net profit is the amount of money left after subtracting a company's total expenses from its total revenue for a specific period of time. The amount depends on the industry and the company's management. It is an indication of a company's profitability.
Sometimes you may use the term net profit synonymously with net income or net earnings and, in some cases, bottom line. Though they mean the same thing, subtle differences exist depending on their position on a company's income statement.
What is net profit formula?
The net profit formula for calculating the net profit is:
Net Income = Total Revenue - Total Expenses or
Net Profit = Gross Income - Total Expenses
The business expenses to be deducted include the cost of goods sold, interest expense on loans and other debts, income tax, depreciation of fixed assets, operating costs, administrative and general expenses. At the same time, the revenue includes all the income from product and service sales and earnings from investments.
The net profit is what companies use to pay their shareholders and invest in that new equipment you've been eyeing, or save for future use. It's calculated for a specific accounting period.
How to calculate net profit
Calculating net profit is straightforward. Gathering all the figures you'll need presents the complex part, but it shouldn't be a problem if you keep proper records. Using the net profit formula above, determines your total revenue.
Total Revenue (net sales) = Quantity of goods/services sold * unit price
Next, you have to add up all the expenses, including:
Cost of goods sold (raw materials)
Depreciation of assets and amortization
Interest on loans
General expenses (salaries).
Finally, you subtract the added expenses from the total sales revenue. The outcome can be positive or negative if you have incurred a net loss.
Why is net profit important?
Net profit is a critical metric for business owners to understand as it points to the financial health of an organization. Loss-making businesses can assess if the losses are sustainable and for how long. In comparison, the ones making profits can plan on how to grow the business further. You can use it for your marketing budget or hiring more people.
Investors are also keen on an organization's net income as it tells them whether they are likely to get a return on their investment. If a company's net profit is consistently positive, it's more likely to attract investors.
Also, lenders use the net profit values to determine if an organization will repay a loan amount—higher net profits place it in a more favorable position with banks and other lending institutions. In addition, comparing your net profit to the previous period lets you know if things in the company are okay.
Net profit margin also points to the overall management of the company's resources. A poorly managed business will not record a high net profit and vice versa. Sound management practices of inventory and expenses are a substantial contributing factor to its growth or downfall.
Examples of net profit
The following are examples of profit and loss calculations to help you understand the net profit calculations.
The financial statement for Microsoft for the period that ended 6/30/2018
Total revenue = $110, 360, 000
Cost of revenue = $38, 353, 000
Gross profit = $72 007 000
Operating Expenses = $14, 726, 000
Selling and administrative expenses = $22, 223, 000
Total operating expenses = $75, 302, 000
Operating income profit or loss = $35, 058, 000
Income from continuing operations
Total other income/expenses net = $1, 416, 000
Earnings before interest and text = $35, 058, 000
Income before tax = $36, 474, 000
Income tax expense = $19, 903, 000
Net income from continuing operations = $16, 571, 000
Net income = $16, 571, 000
Preferred stock and other adjustments
Net income (profit) applicable to common shares = $16, 571, 000
From the edited figures above, the company's total revenue is the sum of total revenue on the first line and other income/expenses net amounting to $111,776,000. On the other hand, total expenses equal the cost of revenue, operating expenses, selling and administrative costs and the income tax added together, giving $95,205,000. Applying the net profit formula, you subtract the two, giving you the bottom line figure of $16,571,000.
Other important figures that you should keep track of include operating profit, total operating expenses and gross profit margin. These are also critical indicators of your financial performance.
In the example above, it is representative of a big company, and it is multistep. The income statement (end of June 2020) for business ABC shows a sale of $60,000. The total expenses were $25,000. They also sold an old van for $3000 while spending $2000 on settling a lawsuit.
Following our net profit formula, we have total expenses equal to $25000 + $2000 = $27,000. Total revenue = $60000 + $3000 = $63,000. Hence, the net profit is $63,000 -$27,000 = $36,000.
How to improve your net profit
Do not despair if your net profit is not what you were looking forward to. Here are a few steps you can take to improve your bottom line.
Your overhead can eat into your profits. Carefully review your insurance, fees, rent, and marketing expenses. Benchmarking with companies like yours helps you see if you fall short of industry standards. Take measures to reduce the overhead and improve net profit.
Have better control over inventory
Managing your inventory is a sure way of improving your net profit. It will help you identify the high-margin products and those that do not sell. In addition, it will help you improve cash flow in your business. You will need to ensure you never run out of profitable products and not tie your cash to slow-moving, low-margin products.
Review your pricing
Most businesses fail to price competitively due to poor pricing strategies. Following competitor pricing, as most do, may do your business profitability ratio a lot of harm, resulting in revenue loss. A slight price adjustment may be all you need to revamp your net income. Smart pricing with the current market status in mind will help you ensure you optimize your pricing for higher net earnings and customer retention. Moving to data-driven pricing is the way to go.
Remove unprofitable goods and services
Eliminate products that are underperforming from your inventory. A careful look into your product data will shed light on what needs to go. You can offer discounts and promotions to move them faster. In addition to taking space in the warehouse, they also increase your overhead due to costs incurred during ordering. Improve on those that remain to help you turn things around.
Reduce direct cost
Direct costs or the cost of goods is another item that affects your net income significantly. Negotiate with your suppliers to get better deals. Those unwilling to yield may be dropped and find others who will give reasonable rates.
How ProfitWell Metrics can help you track important revenue metrics
You need to have the right figures to get the correct net profit. Tracking some revenue metrics manually may lead to many errors that could lead to inflated figures. Subscription-based companies are especially vulnerable to such errors, and they can benefit from ProfitWell Metrics.
We're here to take the stress away by providing accurate revenue reporting. As a result, your net profit will show the actual financial status of your organization. We track metrics such as monthly recurring revenue (MRR) or annual recurring revenue (ARR), and more, at no cost. So you can keep growing your business.
Net profit formula FAQs
How do you calculate net profit?
Net profit is calculated by subtracting total expenses from total revenue. The result can either be positive, or negative if it's a loss.
What is the formula for net profit?
Net profit = Total revenue - Total expenses
This is the simple formula for calculating net profit.
But you can also use:
Net profit = Gross profit - Total expenses to calculate the same.
What is net profit?
Net profit is the money that remains once you deduct total expenses from a company's total revenue. It's an indicator of how profitable a company is.
What does "net" stand for?
Net stands for the value left after you account for a common deduction. For example, net profit is the sum left after deducting total expenses from total revenue.
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