What Is Net Profit?
Also referred to as the bottom line, net income, and net earnings, net profit is easily summarized as the amount of money a company has after all expenses are paid. You can think of net profit like your paycheck: It’s the money left after all taxes and benefits are subtracted.
Found on the last line of the income statement, net profit impacts the “take-home” profit of a company.
This financial element is used to calculate net profit margin and is, therefore, a useful value metric for a company. For this reason, both net profit and net profit margin are used by investors and owners to measure a company’s success.
How to Calculate Net Profit
Net profit calculation is represented by deducting the following from the company’s total revenue:
Net Profit Formula
Calculating net profit starts by reviewing two figures on the income statement: total revenue and total expenses.
Net Profit Example
Let's look at a hypothetical income statement for Company Z:
Income Statement for Company Z, Inc. for the year ended December 31, 2019
|Cost of Goods Sold||(20,000)|
|Total Operating Expenses||(30,000)|
By using the formula we can see that Net Profit = 100,000 - 20,000 - 30,000 - 10,000 - 10,000 = $30,000
When to Use Net Profit
Shareholders can view net profit when companies publish their income statements each financial quarter. Net profit is important since it’s the source of compensation to a company’s shareholders. If a company can’t generate enough profit to compensate owners, the value of shares will plummet. If a company is healthy and growing (with increased profits), higher stock prices will result.
Since changes in net profit are endlessly scrutinized, companies will always be looking at ways to improve their net profit, either by increasing revenue or cutting costs.
Generally speaking, when a company's net profit is low or negative, a myriad of problems could be to blame. These range from decreasing sales to poor customer experience to substandard expense management.
When to Avoid Using Net Profit
Net profit varies greatly between industries so it shouldn’t be used to compare companies. In these instances, it would be more appropriate to consider net profit as a percentage of sales.
Net profit also shouldn’t be used as a measure of how much cash a company earned during a given period. That's because the net profit formula accounts for non-cash expenses like depreciation.
Note: To discover how much cash a company generates, examine the cash flow statement.
Net Profit Margin vs. Net Profit
Net profit margin tells you how much of a company’s revenue translates to profit after expenses are paid. It’s a ratio of net income and is relative to revenue.
More simply put, the net profit margin turns the net profit (or bottom line) into a percentage.
Net Profit Margin Formula
For example, the net profit margin from Company Z would be $30,000/ $100,000 = 30%.
Why Net Profit Margin Matters
There are two main reasons why net profit margin is useful:
1. Shows Growth Trends
Net profit margin is an easy number to examine when looking at the profit of a company over a period of time. Reviewing net profit margin over a period of 5 years can show growth trends within the company.
2. Provides a Better Reference for Profitability
The net profit (which is represented by a dollar amount) can be vastly different between large and small companies. By providing a percentage, net profit margin provides a better reference for comparing the profitability of different companies.
Net Profit vs. Gross Profit
If you refer back to the income statement for Company Z, the gross profit was $80,000 and the net profit was $30,000. The difference between net profit and gross profit is what you'll subtract from the total revenue.
Gross profit shows core profitability before overhead costs. This number can provide motivation for lowering expenses or raising the cost of goods sold (to improve profitability).
When considering the overall financial health of a company, net profit is arguably a better figure to review, specifically because it takes all expenses into account. However, both figures should be reviewed when comparing companies within the same industry.