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Net Profit vs. Gross Profit

written by: •edited by: Michele McDonough•updated: 10/27/2010

If you’re confusing net profits vs. gross profits, you probably don’t even know if you have a profit! These two profits have very different meanings and the one you offer up to investors, lenders or your accountant can make a huge difference. Jean Scheid explains them both.

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    Aren’t All Profits Equal?

    All Profits Are Not Equal If you think all profits are equal, you’d be wrong. So, what’s the difference between net profits vs. gross profits? The easiest comparison tool you can use here is to think of your paycheck—or if you’re a business owner and take a draw—remember an old paycheck.

    On that paycheck you had gross pay and net pay. The gross is your total earnings before taxes and other deductions. Your net pay was the amount after the Feds took all your taxes, the company deducted your health insurance premium, and you put money into your 401(k). You end up with what’s left after all the deductions or your net pay.

    That’s the easiest way to describe the difference between gross profits vs. net profits but how do they compare in the world of business and financial accounting?

    Image Credit (Freedigitalphotos)

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    My Revenues Are Up So Where’s the Money?

    Sales Are Up But So Are Expenses Some months, as a business owner, you really hit those sales revenues but after all the costs of running the business (overhead) and expenses are paid, where’s all the money—or your net profit?

    When businesses are looking for investors, they often choose to show them an EBITDA financial report or earnings before interest, taxes, depreciation, and amortization. Why do they do this? An EBITDA financial focuses on revenues and excludes the costs of those revenues, overhead and other expenses.

    Your revenues may be high, but if your expenses are higher than your sales, expect a negative net profit, even though that gross profit was out of this world. These are the things an EBITDA financial will not show and if an investor inquires about these types of operating expense, you need to be prepared to explain, especially if a full income statement show a net loss on a continual basis.

    Image Credit (Freedigitalphotos)

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    Learn to Manage Your Company

    Learn to Manage Your Company Your expenses, not your gross revenues, should dictate how high your sales revenues should be. Creating, analyzing and comparing a cash flow forecast can help you do this best. By analyzing where your cash is going each month, you can set sales goals or find ways to cut expenses so you do indeed have a positive net profit and not a net profit loss.

    Gross profits vs. net profits are not the same, however, you can also use sales forecasting along with expense tracking to also determine how to keep expenses low so your gross profits are large enough to handle monthly expenses.

    A large mistake made by all new business owners, including myself, is that you have your line of credit, capital funding, or working capital. You spend it—actually overspend it, and before you know it, your sales revenues are not high enough to meet expenses, you have a net profit loss and you are scrambling for money to put into the business. Keep in mind that no investor will invest in a failing business.

    Learning to manage your cash based on sales revenues and expenses is essential in running any business effectively. Sure when you open the doors you want that new (and expensive) display, office equipment or the latest technology. Often, it’s best to get some months of revenues and expenses under your belt before you make rash decisions on expenditures for things that yes, you want, but are they really necessary?

    SCORE, a division of the Small Business Association offers courses and mentors that can help the new business owner better understand gross profits vs. net profits and teach them not only cash management, but business management.

    Image Credit (Freedigitalphotos)