What is Net Profit?
Net profit impacts the “take-home” profit of a company. 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 useful for investors and owners.
Net profit is also referred to as the bottom line, net income, or net earnings. Found on the last line of the income statement, this number represents how much money a company has after all expenses are paid. You can think of it like your paycheck: It’s the money left after all taxes and benefits are subtracted.
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
To calculate net profit, you need to look at two figures on the income statement to calculate. The formula is as follows:
Example of How to Calculate Net Profit
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
What Is 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 Useful
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.
The net profit (a dollar amount) can be vastly different between large and small companies. By providing a percentage, net profit margin gives you a better reference for comparing profitability of different companies.
When to Use Net Profit
Net profit is one of the most closely-followed numbers in finance. It plays a large role in financial analysis and can be used for measuring a company’s success.
Companies publish their income statements quarterly 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 their net profit to try and improve this number. This is done 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 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.
Gross Profit vs. Net Profit
The difference between net profit and gross profit is what you subtract from the total revenue.
If you refer back to the income statement for Company Z, the gross profit was $80,000 and the net profit was $30,000. Looking at the difference between the two numbers tells you how high the company’s costs are. Gross profit shows core profitability before overhead costs. It’s a number that can provide motivation for lowering expenses or raising cost of goods sold in order to become more profitable.
Net profit is arguably a better figure to look at 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.
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