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What is net profit & how to calculate it using the net profit formula

Net profit is an essential indicator of business profitability and financial health. Learn how to use the net profit formula to calculate the net profit for your company and discover some tips on how to improve it.

Businesses can record high revenue but still end up with a loss. Revenue is not a reliable indicator of business profitability; net profit is. It is essential to understand net profit and its importance to the financial health of your business. Investors and lenders are very keen on these figures before investing or lending money.

Net profit tells you how much money you have to pay shareholders, invest, or save. It is also essential for new businesses to break even, as it indicates whether progress is being made. You should strive to have a significant net profit margin every month for your business to grow.

In this post, you'll learn how to use the net profit formula to calculate the net profit for your company, even if you are not an accountant.

What is net profit?

Net profit is the amount of money remaining after deducting a company's total expenses from its total revenue for a given accounting period. This amount varies depending on the industry and the company's management. It is an indication of a company's profitability and can also be referred to as net income, net earnings, or bottom line. These terms are often used interchangeably, though slight differences may exist depending on their placement on the income statement.

What is the net profit formula?

The formula for calculating net profit is:

Net Profit = Total revenue - Total expenses

It can also be expressed as

Net Profit = Gross Income - Total Expenses

How to calculate net profit

Calculating net profit is straightforward. Gathering all the figures you'll need may be complex, but keeping proper records will make it easier.

To determine your total revenue:

Total Revenue (net sales) = Quantity of goods/services sold * unit price

Your gross income takes into account any additional income from other sources, like interest on cash in the bank.

Next, you have to add up all the expenses, including:

  • Cost of goods sold (raw materials)
  • Income tax
  • Administrative tax
  • Research and development expenses
  • Depreciation of assets and amortization
  • Interest on loans
  • General expenses (salaries).

Finally, you subtract the added expenses from the total sales revenue. The outcome can be positive or negative if you have incurred a net loss.

Examples of net profit

The following are examples of profit and loss calculations to help you understand the net profit calculations and the application of the two different versions of the net profit formula.

Example 1: Using gross income

The financial statement for Microsoft for the period that ended 6/30/2018

Income:

Revenue = $110,360,000

Total other income = $1, 416, 000

Gross income = $111,776,000

Expenses:

Product & service = £38,353

Research and development expenses = $14,726,000

Sales and marketing = $17,469,000

General and administrative expenses = $4,754,000

Income tax = $19,903,000

Total expenses = $95,205,000

Net income (profit): $111,776,000 - $95,205,000 = $16,571,000

From the edited figures above, the company's total revenue is the sum of total revenue on the first line and other income/expenses net amounting to $111,776,000. On the other hand, total expenses equal the cost of revenue, operating expenses, selling and administrative costs, and the income tax added together, giving $95,205,000. Applying the net profit formula, you subtract the two, giving you the bottom line figure of $16,571,000.

Other important figures that you should keep track of include operating profit, total operating expenses and gross profit margin. These are also critical indicators of your financial performance.

Example 2: Using total revenue

In the example above, it is representative of a big company, and it is multistep. The income statement (end of June 2020) for business ABC shows a sale of $60,000. The total expenses were $25,000. They also sold an old van for $3000 while spending $2000 on settling a lawsuit.

Following our net profit formula, we have total expenses equal to $25000 + $2000 = $27,000. Total revenue = $60000 + $3000 = $63,000. Hence, the net profit is $63,000 -$27,000 = $36,000.

Why is net profit important? 

Net profit is a critical metric for business owners to understand as it points to the financial health of an organization. Loss-making businesses can assess if the losses are sustainable and for how long. In comparison, the ones making profits can plan on how to grow the business further. You can use it for your marketing budget or hiring more people. 

Investors are also keen on an organization's net income as it tells them whether they are likely to get a return on their investment. If a company's net profit is consistently positive, it's more likely to attract investors. 

Also, lenders use the net profit values to determine if an organization will repay a loan amount—higher net profits place it in a more favorable position with banks and other lending institutions. In addition, comparing your net profit to the previous period lets you know if things in the company are okay. 

Net profit margin also points to the overall management of the company's resources. A poorly managed business will not record a high net profit and vice versa. Sound management practices of inventory and expenses are a substantial contributing factor to its growth or downfall. 

How to improve your net profit 

Do not despair if your net profit is not what you were looking forward to. Here are a few steps you can take to improve your bottom line. 

Reduce overhead 

Your overhead can eat into your profits. Carefully review your insurance, fees, rent, and marketing expenses. Benchmarking with companies like yours helps you see if you fall short of industry standards. Take measures to reduce the overhead and improve net profit. 

Have better control over inventory 

Managing your inventory is a sure way of improving your net profit. It will help you identify the high-margin products and those that do not sell. In addition, it will help you improve cash flow in your business. You will need to ensure you never run out of profitable products and not tie your cash to slow-moving, low-margin products. 

Review your pricing 

Most businesses fail to price competitively due to poor pricing strategies. Following competitor pricing, as most do, may do your business profitability ratio a lot of harm, resulting in revenue loss. A slight price adjustment may be all you need to revamp your net income. Smart pricing with the current market status in mind will help you ensure you optimize your pricing for higher net earnings and customer retention. Moving to data-driven pricing is the way to go. 

Remove unprofitable goods and services

Eliminate products that are underperforming from your inventory. A careful look into your product data will shed light on what needs to go. You can offer discounts and promotions to move them faster. In addition to taking space in the warehouse, they also increase your overhead due to costs incurred during ordering. Improve on those that remain to help you turn things around. 

Reduce direct cost 

Direct costs or the cost of goods is another item that affects your net income significantly. Negotiate with your suppliers to get better deals. Those unwilling to yield may be dropped and find others who will give reasonable rates. 

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How ProfitWell Metrics can help you track important revenue metrics 

You need to have the right figures to get the correct net profit. Tracking some revenue metrics manually may lead to many errors that could lead to inflated figures. Subscription-based companies are especially vulnerable to such errors, and they can benefit from ProfitWell Metrics

We're here to take the stress away by providing accurate revenue reporting. As a result, your net profit will show the actual financial status of your organization. We track metrics such as monthly recurring revenue (MRR) or annual recurring revenue (ARR), and more, at no cost. So you can keep growing your business. 

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