The sales of business, along with net profit, serve as a potent indicator of its operational success. Nevertheless, business owners, financial analysts and investors also use other financial metrics to assess the financial health of an organisation.
In this article
What is Net Profit?
A company’s net profit is also known as its net income, net earnings or bottom line. It represents the financial standing of a company after all its expenses have been paid off from its total revenue.
Notably, it accounts for all financial transactions of a firm other than tax payment. On the basis of this fundamental concept, business owners can avoid miscalculations and develop sound financial strategies.
Typically, net profit in the balance sheet is registered at the financial statement’s bottom line.
How is Net Profit Calculated?
As mentioned before, It shows the sales amount after these following are deducted from the company’s total revenue.
- Operating cost
- Preferred stock dividends
Notably, total revenue is described as the total sales minus discounts and refunds. On the other hand, operational expenses and overhead expenses also include the cost of selling and delivering the product.
The net profit formula is expressed as –
Net Profit = Total Revenue – Total Expenses
To calculate Net profit of a company, its total expenses are deducted from the total revenue it generates.
Example of Calculation
Following is an excerpt from PQR Industries Limited’s Income Statement as of 30th March 2019. Take a look below to understand the components of the net profit formula better.
|Cost of revenue||4,41,78,60,000|
|Total operating cost||60,88,30,000|
|Income tax expense||15,39,00,000|
|Depreciation and amortisation||20,93,40,000|
Net Profit = Rs.[4417860000 (608830000 + 152470000 + 153900000 + 20,93,40,000)
Importance of Net Profit
Besides indicating the success of a business venture, it also discloses the firm’s ability to repay debt and reinvest.
Other than that, net profit proves useful in these ways –
- For the owners: It helps to compute the tax amount that needs to be paid.
- For creditors: Creditors refer to the net income of a company to gauge their repayment capability before sanctioning a loan.
- For competitors: Business contemporaries of a limited company can access details about the net profit to gain more insight into their profitability and proficiency.
- For investors and shareholders: They judge the revenue-generating capacity of a firm based on its net profit. A firm with sustainable it has a better scope of attracting potential investors and shareholders.
Since it is deemed useful for the growth of a firm, business owners are always trying to improve it. Increasing sales volume and reducing overhead expenses are among the proven ways of enhancing the net profit of a business firm.
Net Profit Margin Ratio
It can be best described as a financial ratio that helps to calculate a firm’s profit percentage from its aggregate revenue. Typically, it proves useful in gauging a company’s net profit per unit of income earned.
In simple words, the net profit margin is equivalent to net income divided by the total revenue earned. The net profit ratio formula or net profit margin ratio is expressed as –
Net profit margin ratio = net profit / revenue
Investors, shareholders and business owners can review the firm’s net profit margin to analyse its growth trends effectively.
The net profit of a big and small company tends to have a vast difference. Regardless, one can facilitate a better comparison of their performance by drawing an analysis of their net profit ratio.
Example of Calculation
Let us take an example of PQR Private Limited and MNG Private Limited to find out how the net profit margin is calculated.
Income Statement of PQR Private Limited
|Cost of goods sold||20000|
|Total operating expense||20000|
Net Profit Margin of PQR = (Net income / Revenue) x100
= (37000/100000) x100
Income Statement of MNG Private Limited
|Cost of goods sold||35000|
|Total operating expense||65000|
Net Profit Margin of MNG = (Net income / Revenue) x100
= (143000/250000) x100
Therefore, it is ascertained that the profit margin of MNG Private Limited is higher.
Net Profit vs. Gross Profit
Both net profit and gross profit have a significant role in financial accounting and are closely related to each other. Jointly, they are responsible for determining and maintaining accurate financial records of a company.
For instance, both net and gross profit help to analyse the financial health of a firm. Consequently, it is imperative for company owners to understand them and their point of differences.
To begin with, business owners and investors must be clear about the meaning of gross profit and net profit.
For instance, gross profit is the profit remaining with a company after its direct costs have been deducted from its net sales. Also, gross profit serves as a temporary estimate of a firm’s revenue and helps to lower additional cost.
On the other hand, surplus earnings left with the company after paying off the taxes, interests and operating taxes fall under the purview of net profit. It also comes in handy for analysing a company’s sustainable profitability by aiding the calculation of net profit margin.