Gross profit and net profit sound like jargon, but they are both important measures of how well your business is doing. They tell you critical things about your business’s financial health and it’s important to understand what they mean.
What is gross profit?
Gross profit on a product is the selling price of your product minus the cost of producing it. For a service business, it’s the selling price of your service minus the cost of the time spent doing the job.
Gross profit also refers to total sales (also known as revenue or turnover) minus the total cost of sales. It’s vital to understand your gross profit so that you are not selling at a loss.
What is included in gross profit?
Gross profit includes the costs of selling the item such as delivery charges to ship to the customer and any sales commissions. It also includes the cost of getting the items from the supplier to you, such as delivery (‘carriage’ in accounting terms) and any modifications that you make to it before sale.
How to calculate gross profit
If you buy in items to sell then this is fairly straightforward. For instance, an item might cost £50 plus £5 delivery from the supplier. If you sell this for £100 then your gross profit is £100 – £50 – £5 =£45
Some people prefer to also think about this as a percentage of sales which can be referred to as a gross profit margin (GP%). In this example the gross profit percentage is £45/£100 x 100 = 45%
If you manufacture, then your gross profit calculation will be more complex. For instance it might cost £25 of raw materials and £20 of labour to produce an item that you sell for £100. In this case your gross profit would be £100 - £25 - £20 = £55. And the GP% would be £55/£100 x 100 = 55%
What is a good gross profit margin?
This really depends on what you are selling, the market you operate in and what your other costs are. In retail it is traditionally around 50%. This might sound like a lot until you take into account your overheads such as rent.
Tracking all your costs through the Starling Business Toolkit will help enable you to keep an eye on your gross profit and to ensure that you are not selling at a loss. If you’re making a gross loss then, the more you sell, the more you lose.
Sometimes people talk about profit markup instead of profit margin. We cover the difference between the two in our article on How to price a product.
What is net profit?
Net profit is the selling price of your good minus ALL the costs of running your business. This is the figure that we usually mean when we refer to profit (but it’s always worth checking).
What is included in net profit?
Net profit includes the same costs as your gross profit AND your overheads or fixed costs such as salaries, rent, software and bank charges (if your bank charges these - Starling doesn’t charge monthly fees on the regular business account).
How to calculate net profit
If you use the Business Toolkit the taxable net profit is calculated for you. The tax section has a profit and loss tab that shows the taxable profit as well as the taxable income and allowable expenses. It is the gross profit minus any fixed costs.
If you have a gross profit of £5,000, rent of £1,000, salaries of £3,500, £100 of software and £20 bank charges then your net profit is £5,000 - £1,000 - £3,500 - £100 - £20 = £380
This can also be shown as a percentage of sales (net profit margin). If the sales in our example were £10,000 then the net profit percentage would be £380/£10,000 x 100 = 3.8%
Net profit is usually considered before tax
What is a good net profit margin?
Again this depends on what sort of business you are in but 10% would be fairly normal. If the business owner is taking a low salary then you should be aiming for much higher than this figure.
Gross profit vs net profit
Gross profit is the sales income minus the direct costs of getting the article to sale. Net profit is the sales income minus all the business costs. This is often shown as the formula:
Sales - Direct costs = Gross profit - Overheads = Net profits
This article is intended as general information only and does not constitute advice in any way. For any specific questions, you may want to consult your legal advisor or accountant.