How to Calculate Net Profit

By Indeed Editorial Team

Updated February 22, 2021 | Published February 25, 2020

Updated February 22, 2021

Published February 25, 2020

Whether or not you're an accountant, it can be useful to understand net profit and how to calculate it. This is because, to manage your company's books, it's helpful to know some of the most fundamental financial terms and calculations. Determining your net profit can also be helpful for several other reasons such as determining your company's financial health. Though it won't provide you with all of the details, it can give you some insight as to how your company is performing. In this article, we will define net profit, its importance and how to calculate it.

Related: Learn About Being an Accountant

What is net profit?

Net profit refers to the amount of money left over after various expenses have been subtracted from the total revenue. These expenses can include interest, operating expenses, taxes and more. Net profit is also known as the net income, bottom line and net earnings and is expressed in dollars. It is known as the bottom line since it can be found on the last line of a company's income statement.

A low or negative net profit is indicative of various issues such as fewer sales, poor management of expenses, poor marketing, ineffective pricing, poor customer service experience from employees and more. A high or positive net profit can be attributed to several favorable variables.

It's important to note that net profit will vary depending on the industry you're in and the company you work for.

Related: The Value of Increasing Your Business Vocabulary

What is net profit margin?

Net profit margin is a ratio that is used to calculate the amount of profit a company makes from its total revenue. It is expressed as a percentage. In contrast to net profit, net profit margin gives you a better idea of your company's finances as opposed to just looking at the net profit alone. The net profit margin can be calculated by dividing net profit by total revenue and multiplying that figure by 100 to result in a percentage.

Importance of net profit

Net profit is important for several reasons. Ultimately, it helps determine a company's financial stability. Depending on your role in the business world, it can present various advantages. For example, investors use net profit to determine whether a company is worth the risk of investment. Creditors use it to determine whether they should offer a business loan. As a business owner, net profit helps you to assess where you stand financially in comparison to other similarly related businesses.

Related: Your Guide to Careers in Finance

How to calculate net profit

For net profit to be useful, you'll need to know how to calculate it. Here are the various formulas you can use to calculate net profit:

net profit = total revenue - total expenses

You can also use the following formula:

net profit = gross profit - expenses

If you want to calculate the net profit margin, divide net profit by total revenue and multiply by 100. The formula for this is as follows:

net profit margin = ( net profit / total revenue ) x 100

Here are the steps to take when calculating the net profit:

1. Determine total revenue

To calculate net profit, you'll need to determine total revenue. Total revenue refers to the total amount of receipts from sales. If you don't know the total revenue, multiply the number of goods sold by the price of the goods.

2. Determine total expenses

Total expenses refer to how much is being spent before net income. To calculate this, subtract net income from total revenues.

3. Subtract both values

Now that you have both of the above values, you can calculate net profit. To do this, subtract total expenses from total revenue.

Examples

To deepen your understanding of net profit, consider the following examples:

Example 1

Let's say that in a given period, Company A made a total revenue of $500,000. In this same period, they accrued a total expense of $300,000. Since net profit is total revenue minus total expenses, their net profit would be $200,000 because $500,000 (total revenues) - $300,000 (total expenses) is equal to $200,000.

Example 2

Let's say Company B made a gross profit of $700,000 in 2019. However, they also had various expenses such as rent that amounted to $15,000, employee salaries of $480,000 and supply costs of $300,000. In the end, their net profit would be -$95,000. This is because $700,000 (gross profit) minus ($15,000 + $480,000 + $300,000) is equal to -$95,000.

How to improve net profit

If you're hoping to improve your company's net profit, here are some tips to consider:

  1. Get rid of products or services that aren't making a profit.

  2. Review the pricing of your company's products or services.

  3. Reduce your company's ongoing expenses.

  4. Reduce costs.

1. Get rid of products or services that aren't making a profit

If you have a product or service that isn't yielding a profit, consider removing it from your inventory. This will ensure you're not wasting shelf space or any costs incurred when ordering the product's supplies.

2. Review the pricing of your company's products or services

If you own a business, it's important to compare how much you're charging for a particular good or service in comparison to other businesses offering the same thing to consumers. If you charge slightly more, this could help improve your net profit.

3. Reduce your company's ongoing expenses

In other words, limit your company's overhead. To improve your net profit, consider comparing your overhead to that of other similar businesses in your industry.

4. Reduce costs

This can include a variety of things such as negotiating with suppliers and vendors for cheaper supply costs. It's also a good idea to consider which supplies aren't yielding a profit and eliminating them from your budget. This will help lower any costs your company has incurred.

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