A question that agitates every business owner each month: how much net profit is my business making? Of course, high revenue from your business may suggest that it is performing well. But it doesn’t suggest that there is enough net profit in income statement. You might have a long list of expenses that eat up more than half of what your business makes.
But what indicates your actual profit is your net profit. On the income statement, you will find it at the bottom. Net profit refers to the real cash your business brings in after cutting expenses and the cost of goods.
Many individuals have confusion regarding net profit. To provide you clarity on the topic, we will discuss three things about net profit in income statement that every business owner should know.
1. Net Profit Tells About The Company’s Financial Health
Net profit is the amount left over after the cost of goods and overhead expenses have been paid.
In a business, you either make profits or losses. Net profit measures the success of a company’s operations and how much profits/losses a company makes after all deductions have been made to identify on which side of the line your business lies.
Net profit = Revenue – Cost of Goods Sold – Expenses
Here, the cost of goods means the amount of capital required to manufacture or buy a product/service.
Overhead monthly expenses are fixed expenses of a company. These include utilities, rent, marketing, salaries, insurance, marketing, bookkeeping, and other expenditures that a company bears. The list can have additional costs since that’s in your hand. But the calculation process remains the same.
For example, if a company has total revenue of Rs. 1,00,000 and total expenses of Rs. 80,000, its net income would be Rs. 20,000.
Net profit can be both negative and positive. If it is positive, it indicates that the company is performing well. You can expect to expand your business in the future. On the other hand, a negative figure signifies poor performance and financial instability. It may be because of poor management, high rents, poor quality products, customer service, ineffective prices, or additional expenses. These factors are not fixed and may vary from company to company.
But there are some fixed factors. For example, a company’s management team can significantly impact its profit margin. Good management can help control costs and maximize revenue. Hence, you need to keep track of the same.
2. Net Profit Margin Is A Ratio Of Net Profit To Revenue
Finding out net profit is easy, but how to know how much percentage is profit out of the total revenue earned? That’s what we use profit margin for (which too is easy to calculate).
The net profit margin is a key metric for measuring a company’s profitability. It is calculated by subtracting a company’s total expenses from its total revenue and dividing the result by its total revenue.
Net Profit Margin = Revenue – Total expenses/ Revenue
Let’s take a live example of Tata Consultancy Services Ltd (TCS) to understand this.
For the financial year March 2021, the total revenue made by TCS was Rs. 1,41,363.00 Cr., while the total expenses were 99,243.00 Cr. To find out its profit margin put it in the values in the above formula.
Net profit = (1,41,363 – 99, 243/ 141, 363)* 100 = 29.79%
Thus, TCS had 29.79% net profit for that month, which means 29.79% of the total revenue was profit.
To get an accurate picture of a company’s profitability, investors compare its net profit margin to its competitors. Net profit margins vary by industry, but a company with a higher net margin is typically more profitable than its competitors.
Note: To increase your net income, raise the prices of your products/services and decrease your monthly expenses and cost of goods.
3. Gross Profit Is Not The Same As Net Profit
Many people think that these two terms mean the same thing. But there is a difference between the two. Gross profit is the difference between a company’s revenue and its cost of goods sold, while net profit is the difference between a company’s gross profit and its operating expenses. Gross profit is a good indicator of a company’s profitability. It shows how much money a company makes from its core operations without taking into account other expenses.
Gross Profit = Revenue – Costs of Goods Sold
Net profit is a more comprehensive measure of profitability. It takes into account all of a company’s expenses, including taxes, interest, and operating costs. The bottom line is that net profit is the most accurate measure of a company’s profitability. It gives investors a clear picture of how much money a company makes after all expenses are taken into account.
Impact of Taxes on Net Profit in Income Statement
Nothing ends without taxes, and net profit is no exception. Taxes can have a substantial impact on a company’s net income. As a business owner, you are obligated to pay taxes on your income, which can reduce your net profit. The tax rate that a company pays depends on the country in which it is located and its tax status.
In general, companies based in countries with lower tax rates will have higher net profits than those based in countries with higher tax rates. However, many other factors can affect a company’s net profit, such as operating costs and expenses.
The Bottom Line
Net profit is the top metric in calculating the profitability of a company. To find it, subtract a company’s cost of goods and overhead monthly expenses from its total revenue. With the help of net profit in income statement, you can check the overall financial health of your business. It is also beneficial for investors to check whether your business can generate profits.
You can calculate the net profit margin by subtracting total expenses from total revenues and dividing it by total revenues. It indicates the actual profit percentage out of total revenues. Lastly, gross profit is the difference in the cost of goods sold from the company’s total revenue.
The bottom line is that net profit is the most accurate measure of a company’s profitability. It gives investors a clear picture of how much money a company makes after all expenses are taken into account.