Businesses track profit to understand whether their sales are creating real earnings. Gross profit and net profit are two different ways to measure those earnings. Gross profit looks at money left after paying the direct cost of making or buying the product sold.
Net profit shows what remains after all business expenses are paid.
Key Facts
- Revenue is the total money earned from sales before expenses are subtracted.
- Gross Profit = Revenue - Cost of Goods Sold
- Net Profit = Revenue - Cost of Goods Sold - Operating Expenses - Taxes - Interest
- Gross Profit Margin = Gross Profit / Revenue x 100%
- Net Profit Margin = Net Profit / Revenue x 100%
- A business can have a strong gross profit but a weak net profit if rent, wages, marketing, interest, or taxes are too high.
Vocabulary
- Revenue
- Revenue is the total amount of money a business earns from selling goods or services before subtracting expenses.
- Cost of Goods Sold
- Cost of goods sold is the direct cost of producing or purchasing the products that were sold.
- Gross Profit
- Gross profit is the money left after subtracting cost of goods sold from revenue.
- Operating Expenses
- Operating expenses are the regular costs of running a business, such as rent, salaries, utilities, advertising, and software.
- Net Profit
- Net profit is the final earnings left after subtracting all business costs, including operating expenses, interest, and taxes.
Common Mistakes to Avoid
- Treating revenue as profit is wrong because revenue does not account for the costs required to earn the sale.
- Subtracting all expenses to find gross profit is wrong because gross profit only subtracts cost of goods sold, not rent, marketing, taxes, or other indirect costs.
- Ignoring profit margins is a mistake because dollar profit alone does not show how efficient the business is at turning sales into earnings.
- Assuming high gross profit guarantees business success is wrong because high operating expenses can reduce or eliminate net profit.
Practice Questions
- 1 A bakery earns 3,200 in cost of goods sold. What is its gross profit and gross profit margin?
- 2 A clothing shop has 10,000 in cost of goods sold, 1,000 in interest, and $2,000 in taxes. What are its gross profit and net profit?
- 3 A business has a high gross profit margin but almost no net profit. Explain two possible reasons this could happen and what the owner might investigate.