Gross profit vs net income: Whenever an investor considers investing in stocks, he actually invests in the company and business behind it. Therefore, it is of utmost importance for investors to understand the business and revenue drivers of the company they intend to invest in.
Popular fund manager and author, Peter Lynch, has rightly said, “Behind every stock, there is a company. Find out what it’s doing.” And in addition to this also find out how much the company is making!
Today we will take a look at the difference between 2 important financial parameters i.e. Gross profit vs net income. Keep Reading to find out!
Gross profit and net income are 2 of the most critical figures investors should pay attention to. Understanding these 2 measures can help in getting an overall picture of the company’s financial performance.
Gross profit vs net income – Understanding The Difference!
1. Gross Profit
The company’s gross profit is the income or profit which is left after subtracting the cost of production and sales of its products from total sales revenue.
While total sales revenue represents how much money a company has received from selling its goods or rendering its services, gross profit exhibits how much money it has earned from those sales since it considers the cost of goods sold.
Gross profit is undoubtedly a valuable measure since it shows whether a company’s process of production is effective or not in comparison to its revenue.
If the gross profit declines because of higher shipping costs, the company should try switching to cheaper shipping services or, alternatively, it can reduce the weight of its product packaging.
2. Net Income
The company’s net income, also known as net profit, is the amount of income that is left after business expenses are subtracted from its total revenue.
Apart from the cost of goods sold, other expenses which are included are operating expenses, income taxes, expenses related to interest on debt, depreciation expenses, SG&A expenses, etc.
For net income calculation, total revenue includes not only the amount of money received from sales of products or rendering of services but income from some other sources, like investments.
Since net income considers all of the expenses and revenue, this measure exhibits the company’s actual profitability during a particular accounting period.
Net income helps investors determine how effectively the company has been managed in the said accounting period. To calculate net income, investors can consider using this simple equation: Net income= Revenue – Expenses
Understanding the Difference Between the Two Measures
Gross profit provides a partial picture of the profitability of the company, while net income helps in providing a complete picture. Gross profit does not account for all of the company’s expenses and income sources, but it does exhibit how efficiently the company operates considering the direct costs involved in the production process.
Net income takes into consideration all business expenses and revenue and provides an accurate measurement of whether the company has been making profits or losses.
Simply put, net income is an all-inclusive measure of profitability and offers insights into how well its leadership team runs its business. For the calculation of gross profit, subtract the cost of goods sold from total sales revenue, like below:
Gross profit = Revenue – COGS
As can be seen from the equation, revenue exhibits the total amount of money earned as a result of product sales, while COGS means variable direct costs of producing the products. These costs include raw material costs, equipment, employee labor costs, shipping costs, etc.
At the time of calculating gross profit, the companies can substitute net sales in place of total revenue. Both the terms can be used interchangeably, but net sales subtract prices of returned sales, allowances, and discounts.
In the net income equation, revenue exhibits the total amount of money earned due to product sales apart from income earned from other places, such as investments. Total expenses include—COGS, operating expenses, taxes, interest expenses, depreciation expenses, SG&A, etc.
The gross profit helps in assessing the company’s ability to earn profits, while simultaneously managing production and labor costs. Comparatively, net income helps determine profit from all aspects of the company’s business operations.
WhileGross profit vs net income are the prominent measures used by analysts and investors to make informed investment decisions, other measures including net profit margin, gross profit margin, operating profit, etc. are equally important.
A combination of these measures can help investors make sound investment decisions.
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