What is Net Profit
One of the essential criteria to evaluate the performance of any business is calculating your company’s net profit. Your remaining funds after paying your expenses are known as your net profit.
The terms “net income” or “net profit” are synonymous. Net profit shows the actual bottom line of your business, or how much money you earned during a given financial year.
The strategy of earning net profits can differ for every business. For instance, the aim of successful online retailers or FMCG industry is to generate net profits month-on-month. This demonstrates that your company is growing and that more expansion is possible. On the contrary, traditional businesses look to generate strong net profits every quarter due to the factor of seasonality. Whereas, young startups tend to make net losses in their setup phase and generate net profits over longer terms when their growth normalizes.
Growing companies might use their net profit to fund new initiatives, business expansion, or capital expenditures. Companies in their maturity phases such as the IT industry use such profits to fund new acquisitions, pay off their existing debt, or make large distributions among the investors.
How to Calculate Net Profit:
Technically speaking, your net profit formula is relatively straightforward “Total Revenue from your Business + Other Incomes – Operating Expenses – Other Expenses – Taxes”
While you may find variations to certain items included above in your net profit formula calculation. However, that depends on the nature of your business. But generally speaking, the above version applies to most of the business.
Pro Tip: Your net profit does not represent your actual cash earnings for a specific financial year. This is due to the fact that your income statement may also contain certain non-cash expenses. For instance, depreciation and amortization. In case you’re looking to calculate your cash profits for a given period, the simple way to do so is by adding up all the non-cash items to your net profit. But if you want to delve deep and understand how much surplus cash does your business generate each financial year, you can look up how to calculate free cash flows.
What expenses factor into net profit?
Variable and fixed costs are both included in the net profit. Variable charges, referred to as the cost of goods sold (COGS), are incurred directly from producing or acquiring the product and vary according to the volume produced or sold. They may consist of:
- Depreciation of the equipment used in manufacturing
- Services for the location where the product is made
It’s easier for e-commerce business owners who don’t produce their goods: your variable expenses are the cost of the item you’re selling. So Revenues – COGS will give you the gross profit of your business. If you’re wondering about the difference between gross profit and net profit, it’s pretty straightforward. Gross profit is directly related to your business operations. It only takes into account the cost incurred to generate revenues from sales. Whereas, net profit shows the overall picture of your company. For instance, for a traditional business, internet and communication or postage expenses are just administrative and in no way linked to sales. But they are still deducted as expenses because you have incurred them during the year. However, for an E-Commerce business, those are primary expenses without which their operations won’t survive. So such e-commerce companies would consider such expenses to arrive at Gross Profit.
Fixed costs are more steady and less likely to alter considerably over time see large fluctuations with growth in sales. They may consist of:
- Office costs
- Wages for workers not involved in the production of the goods
- Advertising costs
- Cost of employee benefits
Why is net profit so important?
Net profit is a crucial measure for business owners to comprehend because it enables you to understand how much money you’re bringing in and how ultimately lucrative your business is.
You may need to assess your company model and strategy to discover where you’re falling short if you’re generating revenues but aren’t profitable (or profitable enough), or you may need a clear expansion plan.
If your firm is profitable, you should consider to capitalize on such surplus money with expansion plans. Possible options include raising your marketing budget, investing in new opportunities, or adding additional staff.
Don’t forget these definitions:
Net profit: Your residual funds after deducting all costs are your net profit. Total Revenue – Total Expenses is how it is determined.
Gross profit: This metric, which quantifies the amount of money left over after deducting only the cost of items sold, excludes other costs like salaries, taxes, and advertising. Total Revenue – Cost of Goods Sold is how it is determined.
Profit Margin: Profit margin is a ratio that shows how much of each rupee of revenue is kept after expenses are considered. Gross profit (for calculating gross profit margin) or net profit can be used to determine profit margin (for net profit margin).
How to improve net profit?
It can be tough for many businesses to set competitive product prices with acceptable profit margins. But consider this, even a small price increase might significantly boost your net profit. Nevertheless, effective pricing plans take into consideration the competition and the price ranges that will remain sustainable in the market while continuing to promote client acquisition and retention.
Remove unprofitable products
To determine both your most profitable and least profitable products, it’s critical to study your product data and calculate your unit economics for each division of your business. This will help you understand which products are highly profitable and which ones are the laggards. You can always develop a market for the laggards if you’re confident and turn them into winners. But, if you have already done enough, only to fail, it’s time to remove such unprofitable products altogether
Inventory management done correctly can boost cash flow and increase net profit. Some of your products will inevitably have better margins than others.
You may order the correct amount of the right products at the right time by keeping a careful check on your inventory and being cost conscious. This will help you avoid tying up your cash flow in things that won’t sell. It’ll also ensure that you have your high-profit products available for customers who want to buy them. Discover advice for profitable inventory management.
Reduce overhead expenses
A quick way to increase your net profit is to regularly assess your overhead costs, including insurance, interest, fees, rent, supplies, marketing costs, and more. If you can, try comparing your overhead costs with your competitors or businesses of similar nature. If you find some areas for improvement it’s worthwhile your time to explore such options.
Reduce direct costs
A strategy to lower your direct costs, also known as your cost of products, is to bargain with your vendors and suppliers for lower prices and stop making irrational purchases. Alternatively, you can try and assess your production methods to see if anything is wrong. Always ensure that your production processes are airtight.
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