Net profit
Also known as net income or the bottom line, net profit represents the actual earnings after all expenses have been deducted from total revenues. For business owners and investors, net profit is the most important performance indicator, revealing the ultimate profitability of a company's operations.
The importance of net profit
Net profit is the clearest indicator of a company's financial health and efficiency. A measure of a company's profitability, it highlights a business' ability to manage its resources and expenses effectively to maximize profit. Net profit tells us what remains after the business has settled anything owed. Also called net earnings, net profit is the amount that can be reinvested back into the business, paid out to shareholders, or saved for future use.
What is net profit?
Net profit is calculated by taking the gross profit and subtracting all operating expenses, interest, taxes, and any other expenses. It's the revenue that remains after every aspect of the business has been financially satisfied.
Formula for net profit
The formula for calculating net profit:
Net profit = Total revenue - Total expenses
Total revenue is the sum of all the income generated from sales and services, while total expenses include the cost of goods sold (COGS), operating expenses, interest, taxes, and other expenses.
Calculating net profit in 4 steps
Computing net profit drills down through a company's financial activities to reveal its profitability.
- Start with total revenue: This includes all income from your business operations within a certain period.
- Subtract the cost of goods sold: COGS is the direct cost attributable to the production of the goods sold by a company.
- Deduct operating expenses: The total operating expenses include the costs required to run the business that are not directly linked to production, such as rent, utilities, and payroll.
- Account for interest and taxes: Subtract any interest paid on debts and the taxes due to get to your net profit.
An example of calculating net profit
Imagine a business that has $50,000 in total revenue. The COGS is $20,000, operating expenses come to $10,000, interest expenses are $1,000, and taxes are $4,000. The net profit would be calculated as follows:
Net profit = $50,000 - ($20,000 + $10,000 + $1,000 + $4,000) = $15,000
The company's net profit, in this case, is $15,000, which is the amount remaining after all expenses have been paid.
A measure of financial performance
Net profit measures a company's financial performance, providing a transparent view of its profitability after all expenses have been accounted for. It plays a critical role in the assessment of a company's financial well-being and strategic decision-making.
FAQs
Why is net profit critical for businesses?
Net profit is critically important to financial institutions, such as lenders evaluating a business for a loan, because it represents the money a business has made after expenses. Those funds are used to pay shareholders, invest in new projects, or save for the future. It's also a key figure when it comes to valuations and financial analysis.
Can businesses still fail with a high gross profit but low net profit?
Yes, businesses can struggle if their net profit is low, even with a high gross profit. High operating costs, debt, or taxes can eat into the gross profit, leaving little as net profit.
How often should net profit be calculated?
Net profit should be calculated regularly, typically at the end of each financial quarter and at the year-end. Regular analysis of gross profit and cash flow helps in monitoring the company's financial health and making informed decisions.
How can LegalZoom help with net profit?
LegalZoom offers a comprehensive range of services to support small businesses as they strive to improve their net profit. These services include: help forming your business, help protecting your brand with trademark registration, establishing an LLC with a Wix website for marketing, getting access to legal advice and forms, tax advice, tax prep services, and more.