What is Net Profit?
Also referred to as the bottom line, net income, and net earnings, net profit represents how much 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 and it’s used to calculate net profit margin (which puts a value metric on a company). For this reason, net profit and net profit margin are both useful for investors and owners, playing a large role in measuring a company’s success.
How to Calculate Net Profit
Net profit represents the number of sales dollars remaining after deducting the following:
These are deducted from the company's total revenue and provide net profit.
The Net Profit Formula
Net profit calculation starts by reviewing two figures on the income statement: total revenue and total expenses. The formula is as follows:
Net Profit Calculation 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
Net Profit vs. Net Profit Margin
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 relative to revenue.
The net profit margin turns the net profit (or bottom line) into a percentage.
How to Calculate Net Profit Margin
For example, the net profit margin from Company Z would be $30,000/ $100,000 = 30%.
Why Net Profit Margin Is Important
There are two main reasons ]why net profit margin is useful:
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.
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.
When to Use Net Profit
Companies publish their income statements each financial quarter, which is when shareholders can look at net profit. Shareholders view net profit closely because it is the source of compensation to shareholders of the company. If a company cannot generate enough profit to compensate owners, the value of shares will plummet. If a company is healthy and growing (with increased profits), the result will be higher stock prices.
Changes in net profit are endlessly scrutinized. Because of this, 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 shouldn’t be used when comparing companies. Net profit varies greatly between companies and industries. In this instance, it is 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. This is because the net profit formula accounts for non-cash expenses like depreciation. To discover how much cash a company generates, you need to examine the cash flow statement.
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 the two numbers tells you how high the company’s costs are.
The difference between net profit and gross profit is what you subtract from the total revenue.
Gross profit shows core profitability before overhead costs. It’s a number that can provide motivation for lowering expenses or raising the cost of goods sold (in order to become more profitable).
Net profit is arguably a better figure to review when considering the overall financial health of a company, specifically because it takes all expenses into account. However, both figures should be reviewed when comparing companies within the same industry.