Gross vs. Operating vs. Net Profit: 4 Key Differences
Updated February 3, 2023
Profit occurs when a company's sales revenue exceeds expenses. There are three main types of profit — gross profit, operating profit and net profit. If you work in accounting, understanding these three concepts is essential for analyzing the financial health of your organization and devising sound approaches to achieving revenue goals.
In this article, we define gross versus operating versus net profit, along with their respective formulas and profit margins and examine the four key differences between them.
Gross profit is the amount a business has earned minus the direct costs of manufacturing or the cost of goods sold.
Operating profit is the amount of the gross profit minus operational costs.
Net profit is the total amount left over after the business has accounted for all deductions, including interest and taxes.
Gross and net profit are standard inclusions on an income statement, but businesses commonly leave out their operating profit.
Each type of profit provides a different set of information about a business's financial health.
What is gross profit?
Gross profit represents a business' earnings after deducting manufacturing costs. Retail companies calculate gross profits by subtracting the cost of goods sold (COGS) from total sales. They then record these values as the first line item on their income statements. Calculating gross profit tells a company whether its production and pricing are efficient enough to meet revenue goals.
Gross profit formula
Calculate gross profit by subtracting COGS from the total sales revenue. The formula for this is:
Gross profit = total sales - COGS
Assume, for example, that you have $10,000 in sales and $750 in COGS. This would equal a gross profit of $9,250.
Gross profit margin
The gross profit margin represents a percentage of sales that you can use to assess the financial health of your company. Higher gross profit margins can indicate efficient processes that support productivity and financial gain. Additionally, the gross profit margin can give you insight into factors affecting revenue generation.
What is operating profit?
Operating profit comes from the total income left after a company subtracts its operating costs from its gross profits. Operating costs can include direct expenses like sales, administrative expenses and overhead expenses. Understanding the operational profit gives businesses deeper insight into productivity and operational efficiency.
Operating profit formula
Operating profit comes from the deduction of indirect expenses from the gross profit, subtracting costs like administrative, overhead and sales costs. The following formula applies these values to give you the operating profit:
Operating profit = gross profit - indirect or operational expenses
For example, if you retain $25,000 in gross profits and have $8,000 in operating expenses — like overhead, administrative costs and sales costs — the operating profit is $17,000.
Operating profit margin
The operating profit margin compares a business' profits against its total sales revenue after accounting for production expenses. By comparing operating profit with total sales, businesses can determine how efficiently sales generate profits. Typically, a higher operating profit margin also means greater production efficiency, likely resulting from effective cost reduction and product pricing strategies.
What is net profit?
Net profit represents all of the income that a business has left over after deducting its remaining expenses, including interest and taxes. A business's net profit is usually the last item on the income statement, showing the total income the business' executives and shareholders earn.
Net profit formula
To find the net profit, subtract all indirect tax and interest expenses from the operating profit. The net profit formula is:
Net profit = operating profit - (taxes + interest)
For instance, if a business has $15,000 in operating profit, $2,500 in taxes and $1,000 in interest, this results in a net profit of $11,500.
Net profit margin
The net profit margin measures a company's net profit against the revenue it generates through sales. The metric is a percentage of total revenues and can indicate how profitable a company is after it deducts all liabilities and expenses. Typically, the higher the net profit margin is, the more profitable the company may be.
Gross vs. operating vs. net profit
While each type of profit relates to the others, there are several key differences to consider when calculating, documenting and applying them toward revenue goals. The four key differences between these metrics are:
Because gross profit, net profit and operating profit require different formulas for calculation, the valuation of the financial metrics for each profit calculation also differs. The distinctions are as follows:
Calculating gross profit requires the valuation of various expenses related to COGS, which may include the costs associated with labor, production materials and inventory.
Operating profit requires the valuation of all indirect costs, including overhead, administrative expenses and fixed expenses.
Net profit depends on the valuation of gross profit and operating profit, and it subtracts the remaining tax and interest deductions.
Gross profit and net profit appear on income statements. The gross profit is typically the first line item, giving analysts and investors a quick look into a business's ability to generate revenue.
The net profit appears as the bottom line, showing the total earnings a business generates after accounting for its taxes and interest liabilities. In contrast, the operating profit sometimes doesn't appear on the income statement, as businesses may choose to subtract all expenses from gross profit to determine the net profit.
Analysis and budgeting
Upon analysis, each type of profit provides a different set of information. For example:
Gross profit can give financial analysts insight into a business to generate sales revenue.
The operating profit shows how efficiently the business turns those sales into profits. With this metric, a business can evaluate whether operational costs are meeting budget objectives, providing a basis on which to form cost reduction and productivity strategies.
Net profit helps demonstrate the business's efficiency, particularly in analyzing and setting budgets that cover taxes and annual interest rates.
Understanding financial processes regarding all levels of profit can help you develop strategies to support improvements across operational, sales and financial activities. Strategy development can vary because of the differences in the financial analysis of each profit type. For example:
With gross profits, managers can look for approaches to reducing the costs of production and materials.
Operational profit can help sales teams develop strategies for product prices and consumer marketing.
Net profits support strategic planning and implementation in investing and funding business growth, resulting in continuous financial stability.
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