Whether you’re a small business owner or professional accountant, you’ll probably be hearing the terms “gross profit” and ” net profit” quite frequently. But these terms can undoubtedly be confusing, especially for newcomers. So if you’re struggling to grasp the concept the concept of gross profit and net profit, keep reading to learn more about these terms and their unique characteristics.
Gross profit is essentially the total amount revenue that’s left over after a business deducts its direct operating expenses used to generate the profit. Gross profit margin is expressed as a percentage of the revenue. For example, if your business earns $20,000 in gross profits and the total revenue (including expenses) was $40,000, your gross profit margin would be 50% — $40,000 divided by $20,000 is 50%. Many businesses use gross profit margin as a measurement of its overall profitability.
Now that you know the basics of gross profit margin, let’s discuss net profit. Net profit is essentially the amount of revenue that’s left over after accounting for overhead. Much like gross profit, it too has a “margin” that’s expressed as a percentage. Net profit margin is the net profit expressed as a percentage of the revenue. Using the same example cited about, a net profit of $10,000 with $20,000 revenue would be 50%.
So, should you pay more attention to gross profit or net profit? Rather than focusing your attention on just one of these metrics, you should analyze them both. Gross profit margin provides a better understanding of how much profit your business makes after accounting for direct operating expenses, whereas net profit margin reveals a similar understanding of the revenue generated after accounting for overhead.
Business owners should carefully monitor their gross profit margin and net profit margin, as this information could prove useful when applying for a loan or other forms of credit. Lenders want to know that businesses can repay the loan, so they check for things like gross profit margin and net profit margin. Failure to monitor this information with your business could prevent you from obtaining a loan. The bottom line is that business owners should constantly analyze their gross profit margin and net profit margin.
Of course, gross profit and net profit are just two of the many accounting terms that you’ll hear when running a small business and/or performing bookkeeping tasks.
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