Whether you’re an accountant or not, you need to understand what is net profit and how to calculate net profit. Basic knowledge of these financial terms is necessary to manage your books and to use them in your everyday life. Calculating net profit is also imperative to determine the financial health of a business. As the net profit provides you with an insight of how a company is performing in a specific period.
Before we delve deep into the calculations of net profit, let’s start with the basics?
Understanding the Net-Profit
Net profit is the money left after the deductions of various expenses against the total revenue. These expenses can be:
- Operating expenses
- Interest and so on
It is also known as the net income, net earnings or bottom line. If your business is facing a negative net profit, it implies that it has:
- Poor expense management
- Poor marketing
- Fewer sales
- Poor customer support
On the flip side, a higher net profit indicates that all the business operations are going good.
How to Calculate Net Profit?
The net profit is the amount left after deducting all the expenses from your revenue. Here you just need to deduct total expenses from total revenue to find out the net profit:
Net Profit= Total Revenue – Total Expenses
You can also calculate the net profit with this formula:
Net Profit= Gross Profit – Expenses
To calculate the net profit margin, you need to divide net profit by the revenue and then multiply it by 100. Here is the formula:
Net profit margin = (Net profit / Total Revenue) x 100
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What Expenses Factor into Net Profit?
Net profit takes into account both variable and fixed expenses. Variable expenses include COGS (Cost of goods sold). These expenses vary based on the amount spent on manufacturing or selling the product. And these expenses occur due to the direct result of manufacturing or acquiring the product. These are:
- Machinery and equipment used to create a product
- Depreciation of those tools used to create the product
- Utilities for the space where the product is manufactured
- Wages for people involved in creating the product
In a nutshell, variable expenses are those expenses that are incurred on purchasing or creating a product that you want to sell. On the contrary, fixed expenses are those expenses that are stable and don’t change significantly with time. These are:
- Marketing expenses
- Employee benefit costs
- Office expenses
- Wages for employees not involved in creating the product
Importance of Net Profit
Net profit is a critical business metric that indicates how much money is coming into your business and how profitable your business is. If your revenue is going up without increasing your profit, you need to examine your business model and strategies to see where you are lacking and how can you improve it to grow.
On the other hand, if you are making a profit, you need to look at the ways to boost your earnings by using the leftover profit to expand your business further. You can also use that money for marketing, investing in new ventures and hiring new employees.
Ways to Improve Net Profit
Here are some of the great ways to improve net profit:
- Review your prices and use smart pricing strategies
- Avoid investing your energy and resources into unprofitable activities
- Reduce the overall direct cost and overheads
- Manage and monitor your inventory carefully
Quick Sum Up
Hopefully, after reading this post, now you have a good grasp of what is net profit and how to calculate net profit. You need to calculate net profit as it provides a clear picture regarding the performance of your business and its financial health. It also assists the investors and creditors before offering a loan. Working out net profit can be a daunting process if you lack financial background. Therefore, we recommend you to take professional help from our accountants.
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Disclaimer: This blog provides basic information on calculating net profit.