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What Is the Difference Between Gross Profit and Net Profit?

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  • Written By: Kathy Heydasch
  • Edited By: O. Wallace
  • Last Modified Date: 22 August 2014
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Gross profit and net profit are terms to describe the revenue of a particular company. The gross profit is the income a company receives minus the actual cost of the items sold. The net profit is the gross profit less overhead costs, like salaries, utilities and other expenses. Net profit is a more significant number than the gross because it represents a more accurate assessment of a company's earnings.

A company's gross profit and net profit are used to evaluate the profitability of a company. There are ways to decrease costs and increase profit, and they fall into two categories: cost of goods sold and overhead. The cost of goods sold is an accounting term used to describe the actual cost of item sold by a business. For example, if a company buys and resells bicycles, then the cost of goods sold would be the actual price paid for the bicycles from the wholesaler. Gross profit would be calculated by taking the annual sales of the bicycle company minus the cost of goods sold.

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The second way to decrease costs and increase profit is to look at overhead costs. Overhead costs are all costs that are not directly related to the actual product bought and sold. These include wages, taxes, utilities, etc. Overhead costs are not used to calculate gross profit, only net profit. Net profit in the example above would be calculated by taking the annual sales of the bicycle company and then deducting both cost of goods sold and overhead costs.

Any company's goal is to maximize profitability, i.e., to make money. The earnings of a company are used to determine its value. This is especially the case with corporations that have shareholders. Those holding stock in a company expect dividends from the profit of the company, and gross and net profit play a significant role in the valuation of a company.

The profit of a company is shown on a profit and loss statement. This is a report which shows annual sales, cost of goods sold, as well as all other expenses. The report can further break down the expenses of a company into categories, such as wages and utilities. If cost of goods sold plus expenses equals more than annual sales, then a company is operating on a deficit and is not profitable.

A company's profits can also be described in terms of percentages. A gross profit margin percentage equals the gross profit divided by annual sales. A net profit margin percentage equals the net profit divided by annual sales.

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