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All companies strive to achieve it and minimize losses to enhance their growth potential. Profit is the amount of money that is left over after removing all expenses incurred in running the business operations. Profit calculations are based on the operational expenses incurred during the accounting year. Net profit is a term that is popularly used to describe the company’s ‘bottom line‘. It is considered to be a true indicator of its performance.
Attracting good investment is needed for expansion. Potential investors check the company’s financial statements in detail before making a decision. The gross profit and loss statements are not taken into consideration. Instead, potential investors prefer to check the net profit or loss statements. These statements provide a clear picture of the financial performance of the company.
The net profit statement is a key indicator of a company’s financial health. Declining net profits often signal issues such as poor management or inadequate pay scales. Companies with consistently strong net profits attract more investors compared to their competitors. Conversely, companies with poor financial records may end up closing operations or declaring bankruptcy.
What Is Net Profit?
Profit is calculated as The amount that is left over after deducting expenses. Net profit is a term that describes a particular type of profit. It denotes a company’s profit margin within a particular period.
Net profit is the measurement of a company’s financial position in an accounting year. It is calculated by deducting all the operational costs incurred while running the company. Taxes, depreciation, and interest on loans are also deducted from the company’s total revenue as operational costs.
Net profit is also called the company’s bottom line net income or net earnings. These different terms can be used interchangeably to refer to a company’s net profit.
Related Read: What is Operating Profit
The Formula for Net Profit & How to Calculate Net Profit?
Using the net profit formula in accounting is a common practice. It helps the management understand the true financial position of the company. Based on this calculation, the management can make appropriate decisions to improve or maintain the status quo.
Net profit can be calculated by deducting the total expenses from the total revenue.
Net Profit = Total Revenue – (Total Expenses + Tax + Depreciation)
Total revenue is the total income generated by the company from the sale of goods or services. In simple words, the receipts obtained by sales are calculated as total revenue.
Another way to calculate net profit is to deduct total expenses from gross income.
Net Profit = Gross Income – Total Expenses
Here, gross income includes income generated from other sources like interest on cash deposits, etc.
Total expenses are calculated as the sum of all cash expenditures that are incurred during the accounting period. These expenditures also include operating expenses like taxes, fees, and interest on loans.
While the formula for calculating net profit may look simple, it is vital to have the correct numbers. Companies need to ensure that their accounting system is up to date. Improper accounting can lead to wrong calculations and financial predictions that can negatively impact the business.
Also Read: Gross Salary Explained: Meaning, Composition, Calculation
What Net Profit Can Tell You
Net profit calculation is an accounting practice that is carried out in every business. It helps to give the management a reliable picture of the company’s growth. Net profits are calculated for the entire accounting year. The management makes appropriate decisions based on these calculations.
By calculating the net profit, the management can get a realistic picture of the company’s financial status. A few things that come to light through net profit calculation are:
- The overall financial performance of the company in a particular accounting year.
- Operational expenses incurred within the accounting year.
- The profit/loss trend in different quarters of the accounting year.
5 Steps to Improve Your Net Profit
Profits indicate the success of a business venture. It is to this end that the management strives to cut down expenses. Different sales and marketing strategies are also put into place in an attempt to increase profits. These common practices help in creating profits within a short time but, they do not help in the long run.
A few reliable steps that management can take to improve net profits are listed below.
1. Reduce Overhead Expenses
High overhead expenses can negatively affect your profit margins and hamper your growth. As overhead expenses include both fixed and variable components, they can be optimized to reduce business expenses. A few simple ways through which overhead expenses can be reduced are:
- Rent your office space instead of buying a property to avoid spending your working capital.
- Opt for a remote working setup to reduce the need for physical working space. A remote setup will allow you to conduct business operations from a smaller office.
- Hire freelancers and outsource work to them to reduce your payroll expenses.
- Automate payments and customer onboarding processes to reduce expenses on office supplies.
2. Have Better Control Over Inventory
Inventory management is a crucial part of running a successful business. There are different types of inventory such as raw materials, in-transit goods, finished products, buffer stock, etc. Proper inventory management is essential to earn profits.
Here are a few tips to help you have better control over your inventory.
- Practice the 80:20 inventory rule that states that 20% of the stock brings in 80% of the profit. Keep track of the 20% stock that sells faster to ensure you meet the demand.
- Audit your inventory regularly to understand the sales patterns.
- Keep track of stock received from different suppliers to compare the product quality. This will help you to avoid investing money with suppliers who do not meet your standards.
3. Review Your Pricing
Product pricing plays an important role in any business. The price of a product often determines its demand. But, it is important to review your product pricing at regular intervals to ensure profits.
Below listed are some pointers that you should consider while reviewing your pricing.
- The cost of manufacturing the product vs the price listed. As prices of raw materials rise, it is essential to adjust product prices to reflect the same.
- Conduct ample market research to understand the pricing offered by competitors for similar products.
- Customer surveys can also help in gathering feedback regarding product quality and pricing.
4. Remove Unprofitable Goods and Services
Every business will have leftover stock that remains unsold. This can be caused by changing market trends, poor marketing, or some unpredictable thing. Whatever the reason, this unsold stock becomes a loss for the business. Identifying such loss-making goods and services will help to remove them and reduce business expenses.
Here are some tips that can help you identify unprofitable goods and services.
- Follow market trends to analyze and predict customer needs. This will allow you to stock profitable products only.
- Compare your products with those offered by your competitors to understand pricing and quality.
- Cut production costs to mark down the prices of goods and services. This will help in promoting a faster sale of the stock.
5. Reduce Direct Cost
Direct costs are the expenses incurred by the business for producing goods and services. Direct costs are operational expenses that include the cost of raw materials, labor, and purchase of equipment. Reducing direct costs can be a little tricky as they can negatively affect production.
Here are some effective tips that can help you to reduce direct costs without impacting sales.
- Negotiate with your suppliers to bring down the cost of raw materials purchased from them.
- Plan your own logistic team to reduce your spending on external transport teams for procurement and sales.
- Have better inventory management to avoid spending on the production of unprofitable stock.
Also Read: 15 Profitable Online Businesses from Home in India to Amplify Your Earnings
A comparison Between Net Profit vs Gross Profit
Gross profit and net profit are two factors that help in predicting the company’s financial growth. Although both these terms sound similar, different variables are used for calculating gross profit and net profit.
Here is an explanation of the difference between gross profit and net profit.
Gross profit
The gross profit earned by a company can be calculated by deducting the cost of goods sold from the total revenue. Here, the cost of goods sold also includes operational expenses like the cost of equipment, labor, repairs, raw materials, etc.
Formula
Gross Profit = Revenue – Cost of Goods Sold
Gross profit calculation is essential for determining whether the business is efficient or not. The proper usage of raw materials, production supplies, and labor is considered for calculating gross profit.
Net Profit
Net profit is the profit that is left over after all the expenses have been deducted from the company’s revenue. The net profit of a company is also referred to as its bottom line. The calculation of net profit is essential for formulating new business strategies. Potential investors also check the company’s net profits as a part of their research before making a decision about investing in it.
Formula
Net Profit = Gross Profit – Expenses
Here, expenses also include rent, salaries, depreciation, and the cost of utilities. If this formula yields a negative number, then it signifies net loss. In some cases, companies that have a good gross profit may still incur a loss due to their high operating expenses. Net profit calculation helps business owners get a clear picture of their sales and operating expenses.
Getting Started with Small Business
Are you interested in starting your own business but are low on capital? Don’t worry, you can still fulfill your dream by starting a small business. Many small businesses are thriving in recent times thanks to the power of social media. If you have a business idea then you start your own company without much hassle.
Some small business ideas that can generate good profits are
1. Home baking
2. Apparel
3. Painting/Gifting
4. Handicrafts
Some great advantages of starting a small business are:
1. You can start it from your home with minimal labor to reduce costs.
2. Engage your family and friends to help you out with different aspects of the business.
3. Creating engaging online content to promote your business and develop a strong customer base.
If you are short of capital to start your own business then don’t worry. You can quickly earn some by working with Chegg as a Q&A Expert. This is a 100% remote work opportunity that allows you to earn money from home. As a Q&A expert, you will need to answer questions posted by students from all over the world. To get started, simply login to Chegg and follow the recruitment process.
Innovative, low-investment ideas for the hidden entrepreneur in you! Explore our guide on Business Ideas.
Frequently Asked Questions
Q1. How net profit is calculated?
Ans. Net profit is the amount that is left over after deducting the company’s revenue from its expenses. The net profit calculation can give a clear picture of the company’s financial position. The formula for net profit calculation is:
Net Profit = Total Revenue – (Total Expenses + Tax + Depreciation)
Q2. What is net profit called?
Ans. Net profit is also called the company’s bottom line. This term is used because the net profit of a company is found at the bottom of its Profit and Loss statement.
Q3. What is net profit? Give example.
Ans. Net profit is the profit created by a company which is calculated by deducting the company’s expenses from its revenue. For example, a business AB has a revenue of Rs. 45000 and incurs an expense of Rs. 35000 in a financial year. Then the net profit of AB can be calculated as:
Net Profit = Revenue – Expense
Net Profit = Rs. 45000 – Rs. 35000 = Rs. 10000
Q4. What is net vs gross profit?
Ans. The company calculates net profit by deducting the total expenses incurred by the company from its revenue. Here, expenses include operating costs, tax, and depreciation. This calculates gross profit by deducting the cost of goods sold from the company’s revenue. Here, the company adds the cost of raw materials, labor, and repairs.
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