The terms Gross Profit and Net Profit, as one component of the Income Statement, often confuse many people, especially business people. Quite often, people confuse the meaning of the two terms. And obviously, the two words have different definitions and functions. Generally, businesses or companies use these two terms to describe financial ratios and profit margins.
This article will explain these two terms in detail. So you can understand and not be mistaken in interpreting the two conditions. So, what is the difference between gross profit and net profit? First of all, you need to know the definition of each of the two terms. Look at gross profit ratio website for more information about gross profit ratio.
Definition of Gross Profit
Usually, businesses or companies use the terms gross income and Gross Profit interchangeably. This means that according to business, Gross Profit is the number of net sales after deducting the Cost of Goods Sold (COGS). In other words, this is the amount of profit or income left after all the costs of manufacturing the product have been accounted for. Types of expenses, such as sales, administration, or tax, are not included in the calculation of Gross Profit. Businesses use the gross profit to calculate the amount of residual income that can be used to pay these costs.
As a simple example, PT Agus Semesta has the Profit and Loss Report data as follows:
Net Sales: IDR 95,000,000
COGS: IDR 30,000,000
Administration fee: IDR 15,000,000
Sales or Marketing Fee: Rp. 20,000,000
Taxes: IDR 5,000,000
Referring to the data, Gross Profit from the company is IDR 65,000,000 (Net Sales – HPP). As mentioned earlier, Administrative Costs, Sales or Marketing Costs, and Taxes are not included in the gross profit calculation. This is because the three types of costs will later be included in the calculation of Net Income.
Definition of Net Income
For businesses, Net Profit is the amount of revenue after deducting total costs outside of COGS. In other words, Net Income measures the amount of profit left in the business after all expenses have been paid in a period. Net income can be deposited by the company in the Retained Earnings account or can be distributed to shareholders in the form of dividends.
Sometimes, companies or businesses also use other terms in the term Net Profit. These terms are Profit Before Tax, Profit Before Interest and Tax, or Profit Before Interest, Tax, and Depreciation. In principle, the conditions are following the context of each sentence. For example, Profit Before Interest and Tax means Net Profit before deducting interest costs and taxes, and so on. Management or investors commonly use these term differences in weighing business decisions through various Financial Ratio calculations.
Still referring to the previous example of the Profit and Loss Report data, the amount of PT Agus’ Net Profit is Rp. 25,000,000 (Gross Profit – (Administrative Costs + Sales or Marketing Costs + Taxes)).
Justification of the Difference Between Net Profit and Gross Profit
After knowing the definition of Gross Profit and Net Profit, you can also find out the differences and functions of Gross Profit and Net Profit. Businesses use the term Gross Profit to indicate the amount of income left at the end of a period that can be used to cover operational costs (Admin, Sales or Marketing Costs, etc.). And this is the amount of income after all COGS has been paid. Typically, Gross Profit is used in the formulation of Gross Profit Margin and other Financial Ratios.
Businesses calculate their Net Profit at the end of the year by reducing all operating costs from Gross Profit. Net Income is reported at the bottom (Bottom Line) of the Income Statement. The value of Net Profit is also used in various Financial Ratio formulations such as Earnings per Share, Net Profit Margin, and others.