Keeping a close eye on your finances is vital as a small business owner but understanding exactly which numbers you need to have close sight of and the differences between them can take some time to master.
Often, it’s your profits that provide a good indication of your company’s health and will help inform the most important business decisions. However, the old saying that ‘cash is king’ is still very relevant today and gives lots of business owners more confidence to push ahead with their plans.
When it comes to analysing the profit in your business, there are two important metrics you need to be aware of, as well as understanding what makes them different. These are gross profit and net profit.
What is the difference between gross and net profit?
In simple terms, gross profit refers to your earnings before you deduct your direct costs – the additional costs incurred as a result of producing, selling or manufacturing your product or service.
Your net profit is your earnings after you subtract all of your indirect costs. These are sometimes referred to as fixed costs, so include things like rent, utilities and staff salaries.
Here we break down everything you need to know about gross profit and net profit.
What is gross profit?
Gross profit is an important measure for determining the financial performance of a business and reflects how much money your business makes when compared against the cost of producing and selling a product – also referred to as the cost of goods sold (COGS) for companies that sell physical products. Generally speaking, a high gross profit margin could indicate good financial health, but this is not always the case.
Important: Gross profit does not take into account additional costs such as rent, indirect staff costs, taxation and other indirect costs, which is why it’s vital you measure both gross and net profit.
How to calculate gross profit margin?
Calculating your gross profit will show you your top line earnings and is represented in pounds and pence. Your gross profit figure is calculated by subtracting COGS from revenue.