Gross profit vs. net profit: What each one means on your P&L
High sales but low bank balance? Gross profit and net profit on your P&L may hold the answer. Learn what each figure means and how they impact your business. Presented by Chase for Business.
- Gross profit measures how efficiently your business produces goods and services, while net profit reveals what remains after all expenses are paid.
- Knowing the difference between gross and net profit may help you make more informed decisions about pricing, cost control and whether your overall business model is sustainable.
- Both figures appear on your profit and loss statement (P&L), with gross profit near the top and net profit as the final bottom line.
Understanding your profit and loss statement (P&L) can be an important part of running your business successfully. If you have ever looked at high daily sales numbers but wondered why your business bank account balance seems low, your P&L may hold the answer.
Learn more about gross profit and net profit, including how to calculate them and why recognizing the difference may matter for business owners, investors and lenders.
What is gross profit?
Gross profit represents the amount your company earns from sales after subtracting the direct costs of producing the goods or services you offer. These direct costs—known as cost of goods sold (COGS)—generally include raw materials, production labor and manufacturing expenses. For a retail shop, this might be physical inventory. For a creative agency, it often includes subcontractor fees. For a software company, it typically includes cloud hosting costs.
Why it matters: Gross profit may be a helpful measure of how efficiently your company creates products or provides services. It excludes indirect costs such as rent, utilities, marketing or administrative expenses. By focusing solely on direct production expenses, gross profit may provide clarity on the core profitability of your main business activities.
Comparing your gross profit over time or against industry standards may help you identify trends or improvement opportunities. A decline in gross profit margin may suggest increased production costs or a need to adjust your pricing strategy.
How it's calculated
You can calculate gross profit using the following formula:
Gross profit = Revenue - COGS
For instance, if your business generates $100,000 in sales and incurs $60,000 in direct costs to deliver those goods or services, your gross profit would be $40,000.
What is net profit?
Net profit shows what remains after subtracting all business expenses—including direct and indirect costs—from your total revenue. This covers operating expenses, interest, taxes, depreciation and other costs not directly linked to production. Examples include office rent, software subscriptions, marketing campaigns and your own salary.
Why it matters: While gross profit may show if your core product is viable, net profit often reveals if your overall business model is sustainable. It is often considered the true bottom line that can dictate how much cash you can reinvest, save for emergencies or distribute to owners.
How it's calculated
Net profit follows this formula:
Net profit = Revenue - Total expenses
Continuing the earlier example, if your company has $100,000 in revenue, $60,000 in COGS and $25,000 in other operating expenses, your net profit would be $15,000.
Net profit vs. net income
Net income and net profit are generally considered the same thing. Both terms refer to a company's “bottom line,” or the amount of money that remains after all business expenses, taxes and interest have been subtracted from total revenue.
You will often see these terms used interchangeably on financial statements and in business discussions.
How businesses use gross profit and net profit
Gross profit and net profit provide insights into your financials that may be helpful in guiding business strategy. Here are some ways companies rely on these figures:
- Pricing strategy: Understanding gross profit may enable you to set prices that cover costs and help keep your business profitable.
- Cost control: Monitoring gross profit may help identify when production costs increase, offering a signal to revisit supplier terms or processes.
- Operational efficiency: Net profit may indicate if your overall expense management is effective, influencing decisions about hiring, marketing or expansion.
- Investor relations: Investors, board members and lenders commonly review gross and net profit to measure financial health before approving loans or funding.
Using both gross and net profit together may give you a more complete view of your company, supporting decisions that can help maintain a balance between rapid growth and sustained profitability.
Gross profit vs. net income: Key differences
Though both gross profit and net profit are displayed on your P&L, they address different purposes and may highlight unique aspects of your business's success.
Here are some key differences:
- Focus of measurement: Gross profit highlights efficiency in production by subtracting direct costs from revenue, while net profit delivers a more comprehensive view of overall financial health.
- Expenses included: Gross profit factors in only COGS, while net profit deducts all business expenses, including operating costs, interest and taxes.
- Business insights: Gross profit lets you track the efficiency of production or service delivery, while net profit sums up total profitability.
- Location on P&L: Gross profit usually appears near the top, while net profit is typically the final figure listed at the bottom.
How gross and net profit appear on your P&L
A profit and loss statement is structured to show the step-by-step flow of money through your business. It starts at the top with your total revenue. Immediately below revenue, you will typically see your COGS deducted to reveal your gross profit. This top-level section may be insightful because it often shows if your core product or service is profitable before any other costs are considered.
Further down the statement, your operating expenses, taxes and interest are listed and subtracted from the gross profit. The final line on the report is typically your net profit, which is why it is often referred to as the bottom line.
Lenders, investors and tax professionals often rely on this exact layout to assess the financial health, sustainability and operational efficiency of your business at a glance. Noting where these figures sit on your P&L may be helpful because it can help you quickly diagnose financial issues. If your gross profit is healthy, but your net profit is negative, you may find that your production costs are fine, but your operating expenses are too high.
Gross margin vs. net margin: How they relate to profit
Profit margins allow you to express profitability as a percentage of revenue. Using percentages instead of dollar amounts tied to gross and net profits often makes it easier to compare different periods or benchmark against competitors.
Here’s how to determine each:
- Gross margin: Gross margin highlights how much of every dollar of sales is left to cover operating costs and profit. It is the result of dividing gross profit by revenue, then expressing it as a percentage.
- Net margin: Net margin is calculated as net profit divided by revenue and shown as a percentage. This margin reflects your company's ability to convert sales into actual profit after every expense is paid.
A higher gross margin often points to effective production management or pricing. A higher net margin typically reflects strong overall cost control.
Frequently asked questions
Why should you track both gross profit and net profit?
Monitoring both may help you understand how efficient your production is, as well as overall profitability, which may lead to better decisions.
Why is my bank account balance lower than my net profit?
Net profit is an accounting measure of profitability, not a direct reflection of your daily cash flow. Compared to cash flow, a profit refers to overall financial gain after deducting expenses.
Your bank balance may be lower if you have recently used cash to buy inventory, pay down debt or invest in equipment.
Can a business have a high gross profit but a negative net profit?
Yes, this often happens when a company has strong margins on its products but spends heavily on operating expenses like marketing, research or administrative overhead. Startups frequently operate this way to prioritize rapid growth before achieving overall profitability.
Which profit number does the IRS use to determine my business taxes?
Taxable income often starts from net profit (with adjustments depending on entity type and applicable tax rules). This is the amount left over after all allowable direct and indirect business expenses have been deducted.
Are subcontractor fees and software subscriptions considered direct or indirect costs?
Subcontractor fees directly tied to delivering a client project are usually considered direct costs and factor into your gross profit. However, general software subscriptions used to run your business are typically classified as indirect operating expenses.
