Introduction
A business is required to lodge an income statement for tax purposes to the Australian Taxation Office (ATO). One of the key elements is the profit a business has made over a period of time. Two key numbers in those statements are the gross and net profits. The Australian Government Department of Industry, Innovation & Science business aspect outlines the difference between gross and net profit.
Gross Profit
As outlined in this earlier article, How Does a Profit and Loss Statement Work? gross profit otherwise referred to as gross income is essentially net sales minus cost of goods sold (COGS).
- Gross Profit = Revenue – COGS
Revenue refers to the total amount the business brings in from sales. COGS refer only to the expenses that the business incurs when making the products. Keep in mind, this is not the bottom line for your business.
Example
| Total Revenue | 200,000 |
| Cost of Goods Sold | (50,000) |
| Gross Profit | 150,000 |
As shown in this example, the business brought in $200,000 from sales and spent $50,000 on making their product. Therefore, gross profit comes out to $150,000 for that time period.
Net Profit
As outlined in the earlier article, How Does a Profit and Loss Statement Work? net profit otherwise referred to as net income is essentially gross profit minus all other operating expenses for the business.
- Net Profit = Gross Profit – Expenses
Using the calculation earlier you can determine gross profit. Expenses refer to those outside the COGS which can include operating, interest and tax costs. This is usually referred to as the bottom line of your profit and loss or income statement. If this number is negative, it is known as a net loss.
Example
| Gross Profit | 150,000 |
| Total Operating Expenses | (40,000) |
| Interest | (15,000) |
| Tax | (15,000) |
| Net Profit | 80,000 |
Following on from the earlier example, the gross profit for that period was $150,000. Total operating expenses which usually include payroll, utilities, rent, etc was a $40,000 deduction. With interest and tax both being $15,000. Therefore, using the formula earlier the net profit comes out to $80,000 for the same time period.
Conclusion
It is important for businesses to know the difference between gross and net profit as they indicate different elements of the operations. From an operations point of view, the business owner will be looking to reduce operating costs to increase the net profit. In addition, looking to reduce COGS to cap out the gross profit. Hiring a business lawyer to run through this information with you can be a vital step to assist in improving performance. This information is then useful for investors and lenders who intend to understand your financial health. Traditionally, they look at net profit as an indicator of how much injection is going to take place.
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