The main goal of every business is to solve problems and earn revenue. The revenue or in other words sales is the money that a business receives when the consumer makes a purchase. In order for a business to get higher revenue, business owners must create products or services that would become profitable. Even so, businesses can have high revenue but still end up with a loss. The revenue is important for business success but it’s not a reliable indicator of business profitability, but net profit is.
Net profit is also called the bottom line because this is the final measure of profitability after all expenses have been taken out. To understand the meaning of net profit you must understand what is the definition of profit, the types it is divided into and what is a profitable business.
What is profit?
The profit is a measure that determines a business’s financial growth. For this reason, it’s important for businesses to make a profit. The profit is the amount of money that the business earns after accounting for all expenses. This can be accomplished if the product is better than the competitor’s or if it’s innovative or so-called unique.
What are the different types of profit?
To understand the business’s true financial standing, the profit is separated into three categories:
Gross profits, operating profit, and net profit (bottom line). These metrics help entrepreneurs understand the profit their business is generating and which areas are earning the most revenue.
What is gross profit?
Gross profit is also known as gross income or total revenue. This metric shows the direct income that a company receives from the products after deducting all the direct expenses. The total costs incurred to produce the required goods are called “cost of goods sold (COGS)”. Gross profit helps entrepreneurs by showing them how well the business is performing and the aspects of the business that are most valuable.
What is operating profit?
This is the total income after paying all business costs, but before paying taxes. For many startup businesses, this is a very important metric for profitability. Operating profit shows if the entrepreneur is spending more money to manage the business than he is earning.
Net Profit
Net profit is also known as net income or net earnings. This is the total amount of money that the company receives after all expenses and taxes are paid for a certain period of time. This metric shows the financial health of the company. If the business doesn’t make a profit, the entrepreneurs can assess for how long the losses are sustainable. The ones who make a profit can make a plan for growing their business further. Monitoring the net profit in the individual periods allows the entrepreneur to see if things in the company are going well. Here is a formula to calculate net profit:
Net Profit = Total revenue – Total expenses
In the formula above we can see that the net profit is the total revenue (gross profit) minus the total expenses.
What are expenses?
An expense is the cost of business operations that a company incurs to generate revenue. Total expenses are the sum of the costs spent toward running the business. There are two types of expenses that a business can incur: overhead and operating expenses.
- Operating expenses (OPEX) are costs that a business is spending for its management, such as rent, utilities, marketing, and payroll.
- Overhead expenses are all costs on the income statement except for direct labor, direct materials, and direct expenses. By taking your gross profit and subtracting all expenses you can determine net profit. It’s important to know your overhead costs because they always go up regardless of whether the business is making any revenue. Then you will be able to find solutions to reduce them.
After paying operating expenses and taxes from the total sales revenue what is left is the net profit margin.
What is the net profit margin?
Net profit margin (also known as profit margin or net profit margin ratio) is a financial ratio that reveals the company’s financial health. Net profit margin measures the amount of net income that the business makes from sales revenue. The moment where the total business income is greater than the total business cost is when the business is profitable.
